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History signals that stocks will bounce, but ...

OK, you're gutsy enough to buy on dips. Now how about buying on a dive?
/ Source: The Associated Press

OK, you're gutsy enough to buy on dips. Now how about buying on a dive?

After a scary slump for stocks this spring, that's the question facing many investors. In the three months ended June 30, the Standard & Poor's 500 index fell 11.9 percent, the biggest quarterly loss since the financial crisis. The fear is that economic growth may slow, or stall, and that's got even bulls wondering if stocks could drop even lower.

The good news: If you can muster the courage to buy, history suggests you may be rewarded.

According to an S&P analysis of prices going back to the Great Crash of 1929, stocks tend to climb in quarters following big declines.

"The market is like a rubber band," said S&P Chief Strategist Sam Stovall after finishing his analysis Friday. "Stretch it too far, and it's likely to snap back."

Time and again, the pattern seems to repeat: Investors get carried away selling but then come to their senses and start buying again.

Some details and lessons from Stovall's numbers:

Good follows bad seven out of 10 times
Since Calvin Coolidge was president in the 1920s, stocks have fallen 5 percent or more in 41 quarters. But that was followed by stock rises over the next three months 29 times — or seven out or 10 times.

Rises anticipate recoveries
It is said the stock market looks six months or more in the future, and the S&P data bears this out. Some of the biggest rises come before economic recoveries when unemployment is still high and growth low. For example, the S&P started rising in March last year, at least three months ahead of what many people now believe was the start of the recovery.

The unfortunate corollary: Stocks also anticipate recession. That raises the prospect that the current drop could be signaling a feared double-dip, or back-to-back recessions.

Read Horace
Sure, the Roman poet has been dead 2,000 years but he still offers insight into the market: "The harder you fall, the higher you bounce," he once wrote. Indeed, in quarters when stocks rose after falling 15 percent or more, the rebound averaged 23 percent. The median, or the rise halfway between the highest and lowest, was 9 percent.

The big question is whether this quarter will hold to that pattern.

Steven Ricchiuto, chief economist at Mizuho Securities, isn't convinced. His explanation is a bearish take on the old bullish line during the boom: "This time is different."

He said that recession often clears out "excesses" of booms such as too much debt. But a year or so into this recovery, the consumer still owes too much. Consumer debt stands now at $13.5 trillion, or $44,000 per person — a fall from its peak but still more than 120 percent of wages and investment income, according to researcher Portales Partners. That's up from 80 percent a decade ago.

Ricchiuto also thinks there are still too many people out of work to expect a strong recovery, and thus a bull market for stocks. He also fears deflation, or a consistent drop in prices. Though rare, deflation can devastate an economy, making it difficult for companies to generate higher revenue and borrowers to pay back their debt. Consumer prices fell in May, the second month in a row of drops.

"When was the last time you were worried about deflation," said Ricchiuto. He added, "I wouldn't be buying (stocks). I'm 100 percent cash."

Doug Roberts, chief investment officer of Channel Capital Research, said this quarter could see a stock market bounce though he suspects it won't amount to much.

"People thought the government would prime the pump (with stimulus spending) and then we'd have a V-shaped recovery," he said, referring to a drop in growth followed by a sharp rebound. "But what we're seeing is that the government IS the recovery."

Roberts' prediction: Stocks flat for the rest of the year.

Of course, the market has confounded even overwhelming bearish sentiment. Reflecting the popular notion at the time, Businessweek splashed these famous four words on its cover: "The Death of Equities." The date was August 1979, just before the start of one of the biggest bull markets in history.

Not to be outdone, Time magazine ran a story in September 1988 titled, "Buy Stocks? No way." The S&P proceeded to double over the next seven years.

If you're thinking of buying now, note that the S&P data does include a note of caution notwithstanding its bullish portent. Sometimes those sharp rebounds are followed by sharp falls.

After dropping by double digits in earlier in 2001, stocks jumped 10 percent in the last three quarters of the year. But that was followed by three quarters of declines. Stocks eventually fell to level they had not broached in five years.