Is This the Start of a Bear Market?

A reader left a "quick question" as to whether I thought a bear market has started or if this is just a correction. Well, the question might be quick but can the answer be quick?

First, I would say that my hunch is no. It seems to me that bear markets do not start as dramatically as what just happened last week. I said the same thing about the Q1 dip as that one unfolded too. Anything is possible, of course, but for now I say no bear market.

I wanted to answer the question concisely up front but I have to say I think it is the wrong question - at least for me it is the wrong question. The way I view it is that demand for stocks is either healthy or it isn't -- here I am saying the market above or below the 200 DMA (red line below) is the tell for how healthy demand is.

If there is a problem with demand it makes sense, to me, to be defensive and when demand is healthy it makes sense to be more invested. (By the way, demand for stocks is healthy the vast majority of the time.)

To be clear, there are times where the 200 DMA gets it wrong, and there are several other ways that other people gauge market health. I am not saying the 200 DMA is the only way, and it may not be the best way.

For you managing your own portfolio, it probably is not necessary to worry about animal adjectives to describe the market. I also don't believe it is necessary to outguess the next bear market or correction. If you own stocks you have to be willing to endure "down a little". Right now the S&P 500 is not down anywhere close to the 10% that usually defines a correction, so still "down a little" - very little really.

My approach is simply to be invested most of the time, stay reasonably close to the market over time and try to miss a big portion of down a lot. For people who have saved enough, this is sufficient and means that unreasonable risk does not need to be taken.

The market goes up enough over time to give people who save properly enough money when they need it, so people do not need to take on as much volatility as it seems like they do. Further missing a chunk of one "down a lot" in your lifetime can add nicely to your average annual return.

This sort of approach or view of the market is difficult for a lot of people to grab on to. Ken Fisher talks about how human beings are not wired for investing, and I think this is part of it. People seem to want to make big bets on volatile parts of the market and often do so with poor timing.

The building block for this is that if you save properly, stay in equities and never take defensive action you have good chance to having enough money. In that context, the things I write about are my effort to simply give clients a smoother ride to that end.

Comments

[Jim Glazen:]

right....just stay fully invested in stocks for the long term and go to bed. better yet, give your money to Ken Fisher so he can buy another place in the Hamptons.

who cares about the housing bubble imploding, the credit bubble imploding, the $900 billion annual trade deficit, the negative savings rate or record high debt levels.

just buy more stocks every day and never sell.

lmfao!!!

2007 Jul 29 02:00 PM

[patrickpt10:]

do you think any of this market decline has any link what so ever to naked short selling or the issuance of counterfeit shares into the market?

reg sho rules just changed and is now in the federal register.
there is a sub-prime company in california that made some investments based on naked short sales. orange country register carried the story in the last few months.
blogs.ocregister.com/m...

2007 Jul 29 02:04 PM

[Roger Nusbaum:]

My opinion is that naked short selling is big enough to be a top down issue. It could be a bottoms up issue for sure but if I am correct it would not move the needle in a meaningful way over any period of time.

2007 Jul 29 05:15 PM

[Jim Glazen:]

the 1929 crash was blamed on the short sellers as well. the cause of the bust is the unsustainable boom. borrowing on the house and going on spending sprees is not sustainable.

what is so incredible to me is that most people can't grasp that simple fact.

2007 Jul 29 02:07 PM

[patrickpt10:]

it seems that almost immediately after the sec voted 5-0 to change this reg sho rule that this volatility began to rear its ugly head.
if i remember correctly the sec at first denied the existence of naked short selling, then they realized it maybe a problem but not that big of a deal to ok we better take a harder look at this to finally saying ohh chit we got a problem. which brought us to the rule change.
i am in 100% agreement of the rule change, what i dont agree with is the silence from the sec now. why hasnt there been a public statement on major media and news papers across america so us investors might be a bit more informed about the situation. there may be a reason the facts on this (nss) issue are very difficult to find. they (sec) are scared.

2007 Jul 29 03:38 PM

[mslasky:]

The subprime mess is a few hundred billion - global equity valuation is tens of trillions. The magnitude of the problem is insufficient to cause a recession. This is fear overcoming greed - temporary, a buying opportunity.

2007 Jul 29 04:08 PM

[Jim Glazen:]

subprime mess is a symptom, not the disease. consumers went hog wild on a debt induced spending spree combined with massive speculation in all assets. now the party is ending. time to go to bed and deal with the hangover. history will show that lowering rates to 1% to trigger a 4+ year spending/speculation frenzy while at the same time gutting the productive capacity to generate income is one of the all-time biggest economic blunders.

equity valuation in the tens of trillions can evaporate quickly once risk aversion sets in, especially as revenues and earnings dry up due to the inability to carry on with the debt financed spending binge.

I hope the bulls buy every dip on the way down expecting a bounce that never comes.

enjoy!

2007 Jul 29 04:36 PM

[Roger Nusbaum:]

In the really long run everything has been a buying opportunity but 20% declines have started with less important catalysts than whatever the real economic impact of subprime will turn out to be.

I am not trying to predict a 20% decline but we are overdue for a normal bear market. If one starts in the next 12 months subprime has a good chance of receiving the blame in the media.

2007 Jul 29 05:19 PM

[k_denninger:]

I believe there is a significant chance we are about to see "down a lot."

The 200DMA, as mentioned, is a good marker.

Take a look at the Russell 2000. That would be the definition of "down a lot" starting, and when one major index rolls over like this, the others <b>usually</b... (but not always) follow.

Therefore, I believe it is prudent to take protective steps. But then again, I thought that was true a while ago. Now it appears that we may be facing exactly the scenario that I believed was coming.

Valuations are actually quite expensive, if you take out the radical underperformers since January. Remove the financials from the S&amp;P and you'll find that the overall P/E is quite high. On the Nasdaq its even worse.

Reality is that there has been a big LBO "PUT" on the market for the last year or two. This is disappearing. Therefore, you must now go back and re-evaluate what is a rational valuation for the market <b>without</b... that PUT.

When I do that, I find myself staring at a 20-30% downward adjustment from where we are now.

2007 Jul 29 05:20 PM

[patrickpt10:]

In it's report, the BIS used a controversial word “Depression” (and they avoid inflammatory words like the plague) to describe what they thought might happen if US Real Estate and related financial markets were to meltdown. It is not exactly rocket science to understand that such horrific mark downs of major portfolio holdings would trigger catastrophic margin calls on leveraged portfolios. In turn, this would meltdown all securities in the US and globally, in that they would have to be sold in a non-orderly manner on a massive scale to satisfy said margin calls. This process would be a never ending cascade of more calls triggering more calls.

2007 Jul 29 05:39 PM

[slickvguy:]

Nobody knows where the market is heading. Period.
Bear market? Only in hindsight will we know.

I find all such speculation worthless.

2007 Jul 30 12:30 AM

[huangjin:]

The market decline last week is at the very least a warning of things to come.

What I don't like is investor psychology. Michael is right that the subprime mess really isn't that big, and these financial problems are bad but nothing close to doom and gloom. However, the average homeowner doesn't expect their home price to be 10-15% less sometime in the next couple of years. The mistake I fear is assuming that everyone holding stocks like GS, LEH, BSC, ITB, etc., have discounted the worst. The outlook could improve, but it could still be worse than many are expecting and send prices lower.

2007 Jul 30 09:10 AM