Most people now agree that the current financial crisis is a once in a lifetime collapse of the world economy. While we don't yet having any way of knowing the ultimate depth of the contraction, the threat to the world economic system has been the greatest since the Great Depression of the 1930s.
In a single week in mid-September, the last of the major Wall Street investment banks failed or became commercial banks, the largest U.S. commercial insurance company had to be bailed out with more than $125 billion, money market funds began to fail and needed to be guaranteed to prevent a run and Congress debated a bailout of the commercial banking system. In short, in one week, under a conservative Republican laissez faire administration, the U.S. went from a regulated but free market financial system to a heavily government run network of financial intermediaries. And everyone could only hope for the best.
That week turned out to be the worst in stock market history with a decline of about 18 percent in the broad averages. As one commentator put it a few months earlier, "If you think you understand what's happening, you aren't paying attention."
To put stock market performance in perspective, the stock market is flirting with declines that challenge the worst performance since we began keeping good records in 1926. That includes the current record-holding period of the 1930s, when the brunt of the Great Depression hit. Depending on which of the broad averages one uses, last year's decline was about one-third, which was the worst calendar year performance since 1931 or 1937 (the S&P 500 and Dow Jones Industrial Average respectively). All told, about $7 trillion of stockholders' wealth vanished in the U.S. (wiping out the gains of the last 6 years) and approximately $26 trillion disappeared worldwide.
By some measures the market could still decline further based on estimates of market declines during past financial crises. A study by economists Carmen Reinhart and Kenneth Rogoff of past financial crises, http://www.economics.harvard.edu/faculty/rogoff/files/Aftermath.pdf, would indicate a further ten percent decline is possible.
Using another measure, however, this is already one for the record books. Over time the stock market has trended upward at a pace of about 10 to 11 percent per year. That trendline is consistent over long periods. Individual years differ widely with gains as high as 54 percent (S&P 500 in 1933) to a decline of 43 percent (S&P 500 in 1931). Over longer periods, the market, which reflects economic activity, is much more consistent. Good decades make up for bad decades and the returns catch up with the long-term trends.
Prior to the current decade, the worst decade, not surprisingly was the 1930s, with an annualized return of -0.1 percent per year, or nearly flat. In the 1940s, spurred by a post-war boom, the annualized return was +9.2 percent, followed by an ebullient market in the 1950s, returning +19.4 percent per year. The first half of the 1960s was relatively strong followed by weakness later in the decade as inflation hurt the economy. For the decade, the annualized return was +7.8 percent. In the 1970s, which had two big recessions and rampant inflation and a big bear market mid-decade, the return for the whole decade was still a positive +4.6 percent. In the 1980s, a two-year recession gave way to a long-term recovery and bull market and a +16.1 percent annualized return. The 1990s followed a similar pattern with an early recession giving way to a record peace-time expansion and an annualized return of +17.9 percent.
Now we are nearing the end of what may turn out to be the "lost decade." The Dow, the most popular market barometer, breached 10,000 in 1998. It now hovers around 8,000 or a decline of 20 percent. For the decade of the 2000's, the annualized return to date of the S&P 500 is -6.8 percent. Using the S&P 500, the broadest major indicator, and calculating by decade, this will be the worst decade in the 80 years of modern record keeping unless the market returns to near record levels and rallies by close to 75 percent this year. While possible, it certainly doesn't seem likely and this period is likely to go into the record books as the worst decade for the market in the modern era.
The silver lining in this debacle is that the market tends to revert to the trendline over time. That means good periods eventually follow bad ones. Great bull markets are borne in the ashes of terrible bear markets. While the sunshine won't necessarily break through soon, eventually the storm will depart.