Markets Q&A: We Answer Your Questions

by the Schwab Center for Financial Research
Updated July 7, 2009

Each month, we receive thousands of questions from Schwab clients. Here, we tackle the top questions on the markets, with answers and guidance that we believe will address some of your most pressing concerns.

If you have a question that doesn't appear below, we have more Q&As on timely topics in the box at right. If you have a question that we haven't already addressed, you can submit it using the Editor Feedback form at right—we may include it when we add new questions and answers.

To talk to a Schwab investment professional about your particular circumstances, please call 800-435-4000.

On the markets

NEW: How many months before a recession's end does the market usually rebound?
NEW: Where has all the money that's been taken out of the market been placed? How soon will it return?
NEW: Do you think Europe or Asia will lead or trail the U.S. recovery? How can you tell?
What are the traditional indicators that a market may have bottomed out?
My mutual fund is down 40%. How long will it take to recapture that loss?
What's your view on emerging markets and international investing during the next one to two years?
What rate of return can we expect to see annually for the next 10 years?

How many months before a recession's end does the market usually rebound?
Since the 1930s (including the Great Depression), the average gap between stock market bottoms and recession end dates has been seven months, with the average recession lasting 13 months (meaning the market bottomed, on average, 6 months into the recession). One of the only exceptions to the “rule” of markets bottoming first was the last recession, which ended 11 months prior to the market’s bottom (November 2001 and October 2002, respectively).

Where has all the money that's been taken out of the market been placed? How soon will it return?
Currently, there is $9.4 trillion in cash, bank accounts and money market funds, which equates to 108% of the market value of all U.S. stocks (Wilshire 5000 Index). There doesn’t appear to be an imminent catalyst to bring that money back into the market, but based on the American Association of Individual Investors' asset allocation survey, cash as a percentage of portfolio weight has eased since the all-time high registered in December 2008.

Initially, some of that money moved into higher-yielding areas of fixed income, but lately some of it has moved into equities. We continue to think some sharp rallies are overdue as some of this money (which is earning next-to-nothing yields) will find its way back into higher-risk investments.

Do you think Europe or Asia will lead or trail the U.S. recovery? How can you tell?
The timing of recovery in these regions is highly uncertain, and the significant interconnectedness of the economies and financial system complicates matters.

At this point, we believe that Asia has the best chance of being the first to recover (barring a social upheaval in China) for two reasons:

Asia entered this financial and economic crisis on much more solid footing than many economies in Europe and the United States, and we expect the deleveraging in both Europe and the U.S. to take years. Many Asian economies enjoy a positive trade balance and a positive net foreign reserve position, thanks in large part to the washout that occurred in Asian a decade ago and fortuitous currency policies from China’s perspective, which gives these nations a greater flexibility to utilize aggressive monetary and fiscal policies to jumpstart domestic growth.

Japan is somewhat hamstrung, but China possess significant flexibility in these endeavors. The United States is currently taking the most aggressive steps, which will likely lead to growth in coming quarters. Nevertheless, efforts to bolster domestic growth in China and stabilization in U.S. growth may be enough to help other Asian economies recover.
China is better positioned take advantage of lower commodity prices to secure more advantageous, long-term resource supplies, likely improving their long-term competitiveness relative to Central and Eastern European (CEE) emerging markets. At the same time, developed Europe is contending with the negative ramifications of over a trillion dollars in potentially sour loans to CEE countries.

As for indicators, we are watching the U.S. dollar and commodity prices for signs that stimulus efforts are gaining ground around the globe. Investors rushing to reduce risk and seeking safety in recent quarters has resulted in a run-up in the U.S. dollar. Orderly weakness in the dollar would signal to us that investors are once again seeking more risk.

Although the inventory of many commodities has risen significantly, which may lead one to expect a lagged response in commodity prices when traction is finally found, there has been a substantial supply response by the producers of natural resources. (That is, the cut in production capacity has nearly kept pace with the decline in demand.) We’d expect a lag in that production coming back online, which may result in commodity prices being quite sensitive to any increase in demand.

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What are the traditional indicators that a market may have bottomed out?
Market watchers use many types of indicators to try to identify a market bottom. They range from valuation measures—which are categorized as fundamental indicators—to volume, breadth, volatility and sentiment measures—which are considered technical indicators.

Some of the most common valuation measures include the 12-month trailing and forward price-earnings (P/E) ratios—which are sometimes inverted to E/P (earnings yield) in order to better compare them to prevailing interest rates. Dividend yields compared to market interest rates is another common valuation benchmark used to help identify potential turning points in the market, based on historical comparisons. Price-to-book value is another less commonly used but widely recognized valuation measure.

Unfortunately, because downward earnings estimate revisions, dividend cuts, and write-offs are most prevalent during the most worrisome periods of bear market declines, the very factor within each equation to which prices are compared is a moving target. This renders the use of fundamental indicators to mark a bottom in the market an inexact science, at best.

This is true for technical indicators, as well. The traditional technical indicators of a market bottom are generally divided into four categories: Volume, Breadth, Volatility and Sentiment. Within each category, the specific indicators vary according to preference, but there are common themes behind most of them. Below is a list provided by Ned Davis Research, a widely recognized expert in the field of market analysis.

Volume

Declining/Advancing Volume. (Compares the ratio of advancing volume and declining volume to help identify if investor interest is concentrated on the upside or downside.)
Total Volume Deviation. (50-day average / 200-day average, Ned Davis Research shows results indicating that decisive increases in volume have been associated with above-average stock gains, whereas relatively light volume has been consistent with below-average stock gains.)
10-day TRIN. (The TRIN Trading Index compares upside volume to downside volume and shows whether trading is concentrated in advancing or declining issues.)

Breadth

% of Stocks > 200-day moving average. (When the percentage of stocks above their 200-day moving averages falls to a level indicating oversold conditions and then begins to reverse upward, it generally indicates a significant shift in market momentum and tends to be followed by further gains.)
90-day Advance/Decline. (Calculated by subtracting declining issues from advancing issues and adding the result to a cumulative total. When the Advance/Decline series diverges from the market trend, it can indicate a change in trend.)
Net New Highs/Lows. (New highs minus new lows divided by total issues traded; extremely low readings, which occur only rarely, reflect intense oversold conditions and have most often been associated with market bottoms.)

Volatility

100-day S&P Volatility Index. (The absolute value of the daily percentage change in the S&P 500's close and averaging the daily values during the past 100 trading days; Ned Davis Research finds that high volatility readings have been associated with high market returns while low volatility readings have been associated with weak returns.)
VIX. (Chicago Board Options Exchange [CBOE] Volatility Index represents the implied volatility on the S&P 500 index options. When the volatility [aka fear sentiment] reading has risen to high levels, it has frequently coincided with an intermediate-term peak in stock prices.)
Dow Jones Industrials Intraday Volatility. (Measures historical volatility using the percent difference between the intraday high and low on the Dow Jones Industrial Average; signals are similar to the VIX and S&P Volatility Index.)

Sentiment

Ned Davis Research Crowd Sentiment Poll. (This indicator aggregates several different sentiment indicators. It can help in anticipating reversals in investor psychology, and thus stock prices, going forward.)
AAII Bulls/Bears. (The sentiment indicator is based on a weekly survey of 125 individual investors who are asked whether they are bullish or bearish on the direction of the market during the next six months. At extremes in opinion, the majority has typically been wrong.)
Equity Risk Premium. (Spread between riskier corporate debt and safe Treasuries serves as a proxy for the risk premium demanded; peaks in the credit spread have tended to occur around bear market bottoms.)

Each of these indicators (except for 90-day Advance/Decline) has reached or exceeded levels consistent with previous bear market bottoms. Yet, with every new bear market there is the potential for new standards to be set. And we've have seen many such events in this bear market already. You can find Ned Davis Research commentary in the Schwab.com client area under the Research/Reports tabs. Its daily and monthly reports often refer to some of these specific market indicators.

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My mutual fund is down 40%. How long will it take to recapture that loss?
This question is nearly impossible to answer, given that there are so many different types of mutual funds.

However, let's assume we're talking about a fund whose performance closely tracks the S&P 500 index. Although we can't predict the future, we can look to past market recoveries for some insight into how a recovery might play out this time around.

Since 1926, there have been 10 major bear markets (a decline in excess of 20%). Assuming an investor stayed fully invested and reinvested all dividends and distributions, the table below shows how long it took to get back to breakeven.

Major U.S. bear markets	Decline	Time to break even
Sept. 1941 to April 1942	–79.6%	4.6 years
March 1937 to March 1938	–50%	6 years
Sept. 2000 to Sept. 2002	–44.7%	4.1 years
Jan. 1973 to Sept. 1974	–42.6%	1.8 years
Sept. 1932 to Feb. 1933	–29.8%	2 months
Dec. 1968 to June 1970	–29.2%	9 months
Sept. 1941 to April 1942	–22.4%	8 months
Jan. 1962 to June 1962	–22.3%	10 months
June 1946 to Nov. 1946	–21.8%	2.9 years
Feb. 1934 to March 1935	–20.7%	1 year

Given the current drop and the historical record of past recoveries, it will be no surprise if the (eventual) recovery takes at least a few years to break even, as measured by the peak before the bear market.

The actual speed of that recovery depends, of course, on the future rate of return. For example, if we assume that our hypothetical mutual fund—currently down 40%—returns 8.2% per year on average (Schwab's current expectation for the long-term return of U.S. large-cap stocks), we would estimate that it could take six-and-a-half years to break even.

What's your view on emerging markets and international investing during the next one to two years?
Our views change from time to time based on current market conditions. For our most current thinking, see the Schwab Market Perspective, which we update every two weeks.

What rate of return can we expect to see annually for the next 10 years?
Every year, we update our estimates of long-term returns for the major asset classes. For our current estimates, see What Are the Long-Term Market Prospects for Stocks and Bonds? by Bill Swerbenski.

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Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

International investments are subject to additional risks such as currency fluctuation, political instability and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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