Major Indexes Near Pre-Recession Levels: Is History Repeating Itself?

By Tim Parker | November 06, 2012 AAA

It happened on Oct. 9, 2007. On that day, the Dow Jones Industrial Average closed at a record high 14,165.53 on the back of a Fed report indicating that an interest rate cut was likely.

On Oct. 9, 2008, the markets looked much different. On the one-year anniversary of the highest Dow close on record, the market lost 682 points to close at 8579.19, a nearly 40% drop in one year. The market would continue its downward trajectory to reach a March 9, 2009, bottom of 6547.05, and a breakdown of 53% from its highs.

Fast forward to 2012. The market, fueled by two rounds of quantitative easing and a recently-announced new round, designed to be more massive than the two before it, approached a new all-time high. On Oct. 17 of this year, the Blue Chip Index reached a high of 13,557 - only about 4% away from the 2007 highs. This time, however, the economy is different - or is it?

2007
What did the economy look like in 2007? The unemployment rate was a mere 4.7%, and CNN reported on Oct. 9 that the bull market had just turned five years old - starting after the Dow hit a bottom of 7,755.61 in 2002. Prior to that, in 2001, the economy experienced a mild recession. To fend off a more severe recession the Fed lowered interest rates multiple times reaching a low of 1% in 2003.

With all of that money to lend, bankers, eager to get it into the hands of borrowers, lent it to just about anybody who asked. Borrowers who were otherwise unqualified realized their dream of home ownership.

Things started to go sour when the Fed started raising interest rates and home ownership peaked at 70%. Subprime borrowers could not withstand the rising rates and began defaulting. This caused subprime lenders to file for bankruptcy, which led to what many now call the Great Recession.

During all of this, however, from 2002 until October of 2007, the market continued to rise. Despite the increasingly bad news coming from

Main Street

, Wall Street and most businesses seemed oblivious. Unemployment remained modest and the market recorded an 82% gain.

2012
Looking at a chart of the major averages from 2002 through now, some fear that the events during the first decade of the 21st century could repeat themselves. The Great Recession finally reached a bottom in March of 2009. Since that time, the Dow has more than doubled on the back of historically low interest rates (sound familiar?) and three rounds of quantitative easing designed to provide an economic boost.

Nevertheless, much like in 2001, the economy is far from healthy. The unemployment rate sits at 7.9% but economists note that this only represents people actively looking for a job and leaves out those that have given up, known as discouraged workers. 10.8 million Americans remain underwater on their mortgages, and although the recent S&P/Case-Shiller Home Price Indexes showed a year-over-year increase of 2%, home values are still lower than they were in 2010 when the country was in the midst of the Great Recession.

In 2001, the national average wage was $43,016 compared to the 2011 figure of $44,214. This 3.7% increase over 10 years falls far short of the average 3% yearly rate of inflation.

Just like the run up to the 2007 high, the recent doubling of the stock market came in the midst of less than favorable economic conditions, but as Time Magazine points out, this is partly due to mean reversion. During the recent recession, stock prices plummeted from a valuation of 18 times earnings to around 10; and although the 2001 recession was not as severe, when stocks move severely, the move in the other direction is often just as severe. Other reasons may include easy money from the Fed, the recent election and a relatively quiet eurozone.

The Bottom Line
Recently equity markets sold off before reaching or surpassing the all-time highs set in 2007, but many market analysts believe that it's only a matter of time before new highs are printed, meaning we are currently in a bull market. Wall Street believes that fighting the Fed is a fool's game and with the massive influx of liquidity on the back of QE3, the path of least resistance may be up.

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