There have not been many periods when, after one year, the market is down 40% or more.  But that is the current environment as the S&P 500 is down 45% from a year ago at the close today.

In fact, since 1928, a decline of 40% or more on any trading day from a year ago occurred only 1.5% of the time.

However, this is a little misleading.  Many of the 40% declines on any given trading day occurred during a cascading decline, where day after day, the market was at least 40% lower than it was a year earlier.

For example, October 9 was the first day of this year when the market was down by more than 40% compared to October 9, 2007. October 10 was the second, October 15 was the third, October 22 was the fourth, and so on.  The current decline is really one discrete market event as stocks continue to cascade downwards.

In fact, all of the 40% declines prior to now occurred in only three discrete time periods - from October 1930 through August 1932, from November 1937 through June 1938, and for seven continuous trading days in September and October 1973.

So what was the return of equities a year after the first day when the market fell 40% or more during the prior three periods?

In October 1930, with stocks down 40%, a year later, equities were down - another 40%!  Ouch!  November 1938 was better, rising 25% over the next 12 months.  The 1973-74 market environment was even more positive, as stocks rose 31%.

Returns two years after declining 40% were even more dramatic.  In October 1932, stocks were down 64% after the 40% decline.  In 1939, stocks were largely unchanged, up 21% after two years, which is fairly surprising given that World War II had begun a few months earlier, which I would consider positive, all things considered.  The best market was 1975, when stocks were up 65% after two years.

The markets can and will do anything, and three observations is hardly a scientific sample.  However, stocks were dramatically lower after being down 40% during the worst economic crisis of the last century but up the other two times. 

Is the The Great Hedge Fund Liquidation and Retail Investor Panic due to the de-leveraging of the financial system as bad as the Great Depression?  I do not know.  But using my normalized profit margin of 7%-7.5%, the market is trading at 11x-12x earnings and 1.5x book value.  In my book, stocks are on sale.

Doesn't mean the market can't go lower though.