What follows record setting Dow quarters?

By Prieur du Plessis, on October 4th, 2009 posted in: Guest Bloggers, Stocks, Wall Street

This is a guest post by Barry Ritholtz, editor of The Big Picture Blog and author of the newly released book, Bailout Nation

With futures deep in the red, let’s take a look at how markets do after big quarters. The quarter ending September 30 saw the Dow putting in its best quarter since 1998, up a solid ~15%.

With everyone waiting for a pullback, and yesterday (Thursday] and today [Friday] viewed as the probable start, perhaps its time to review some history. What has happened historically after markets have put in record setting quarters – 15%+?

For the most part, momentum has trumped mean reversion historically. Jim Bianco crunched the numbers, and he found that “stocks returned an average of 1.33% over the month following one of these record quarters, 3.46% over the following quarter, and 9.95% over the following year”.

It is worth noting that these average returns following quarters of 15%+ performance are nothing out of the ordinary. The average monthly return over all periods in the DJIA since 1900 is 0.58%, the average quarterly return is 1.66%, and the average yearly return is 6.90%. If anything, the average returns following huge quarterly gains actually outpace the average returns during all periods.

Perhaps another way to look at it is that these record setting rallies, especially following big selloffs, are themselves a form of mean reversion.

Here’s the table of the past 15% quarters: