Get to Know the Bear

It's been a very ugly couple of weeks, and if the performance of global markets on Monday's Martin Luther King holiday is any guide, there will be some continued ugliness in the US markets this week too. I hope you all have been managing the carnage OK.

While we appear to be way overdue for some sort of bounce, it doesn't appear that it will happen tomorrow. It now appears that we are right in the middle of a bear market, with the decisive break having taken place below 1400. This drops us out of what I had been looking at as a long-term trading range between 1400 and 1550.

We're likely to have some very sharp rallies soon, but until we can get a foothold above 1400 and hold it, I believe that staying bearish is the right move.

So if the bear is going to be around for a little while, we might as well do like these guys and get to know him.

In a bear market all stocks go down and in a bull market they go up.
--Jesse Livermore
This quote might not literally be true, but I think it has more pertinence for the investor than the more antiseptic definition of "a 20 percent decline." In bear markets, things go down that shouldn't go down. Things go down that absolutely can't go down. Things go down that didn't even go up in the bull market. Things go down further than anyone ever thought possible, and then they go down more.

You can't really believe it until it happens to you personally, but I hope that at least some psychological preparation can help you keep your wits about you.

. . .

So what might we expect from a bear market? What should we be doing and thinking? I can't give specific answers, but here's some food for thought, along with some questions I've been asking myself . . .

  • As Random Roger frequently points out, market declines are nothing unusual.
  • For those who haven't spent much time in bear markets . . . rallies in bear markets are generally much sharper, dramatic, and emotionally charged than rallies in bull markets. This is because they are driven both by relief and by short sellers "covering" (buying back) their positions. Don't confuse the vigor of a move with its sustainability.
  • Check out Bespoke Investment Group's examination of historical NASDAQ bear markets (declines of 20+ percent).
  • The "uptick rule," which was intended to reduce market volatility and to keep speculators from thrashing stock prices around, has gone the way of the dodo. For the first time since the Depression, short sellers can now lean on the market and drive it further down without having to wait for a higher price to come over the tape. How is this change likely to affect market declines?
  • The uptick rule died in early July, 2007. Take a quick look at the above chart of the S&P and see if anything springs to mind.
  • Barry Ritholtz brilliantly borrows from Elisabeth Kubler-Ross to evaluate this market according to her "five stages of grief."
  • Get this book and read it now.
  • Basically everything in the world (except the US dollar) has gone up over the last 5 years. So where do we hide now?
  • Similarly, if you see bull markets as a rush of much-needed capital to undercapitalized assets, industries, and sectors, what happens to all of these destinations of capital when the rush has served its purpose by bringing the necessary supply on line?
  • Following from these points . . . could it at least be possible that the path of least resistance is now down for most of the assets that have seen money flow into them recently?
  • Given the world's massive and rising industrial capacity, the chances of a deflationary period do not strike me as zero in the face of a worldwide economic slowdown. I have to say that I do think that the deflationists' arguments have begun looking better lately.
  • The long trading markets of the 1970s provide a good road map for the current difficult situation. This old post may be worth looking at again.
  • What would have to happen for the market to recover and for the worldwide bull market to resume? What is our sign that this decline has been a fakeout and it is time to get long again? I've given you mine; you may want to think about setting up your own signposts now.
  • The Fed ended previous market declines in 1987, 1998, and 2001 with gargantuan injections of liquidity. With the dollar on the ropes, what options now remain? Is there any alternative that doesn't send gold to $2000/oz.?
  • Could all of these injections of money have convinced investors that truly brutal bear markets a la 1929-33 or 1973-74 are things of the past? Has the Fed inadvertently "trained" investors to try to hold their stocks at all costs?
  • Remember that the market didn't care about you when it was going up, and it doesn't care about you now that it's going down. It doesn't care whether you get even on your positions or whether you have enough money left for retirement in 10 years. Please accept that unpleasant truth and take appropriate steps.
  • Careful with the whole "emerging markets are safe havens" idea . . .
  • This chart from Crestmont Research is fascinating and extremely useful.
  • If we start a bear market from a market P/E near the long-term historical average (which it is now), then what kinds of prices might we see at the bottom? Mind-bendingly low ones, possibly?
  • There have been a handful of times in the last century when investors could go into the markets, buy basically anything with their eyes closed, and make fortunes. One was when the US entered WWII and Sir John Templeton had his broker buy him 100 shares of every US stock trading for less than $1. A little over 30 years later, in the terrible bear of '73-'74, Buffett made his Washington Post buy and his reputation. That was 30-odd years ago. If another opportunity like these comes along, will you be ready?
  • "Rarely do we find men who willingly engage in hard, solid thinking. There is an almost universal quest for easy answers and half-baked solutions." --Dr. Martin Luther King, Jr.
Best of luck, and stay safe.