Global Bear Market or Buying Opportunity?

According to a recent Wall Street Journal article discussing signs of a global bear market, $7 trillion in total shareholder value has been lost across major stock indices in the U.S, China, Japan, Russia and the U.K.

From the Wall Street Journal:

A classic bear market starts with a period of exuberance. Then a downturn hits one part of the market, and gradually, the losses spread even to strong companies. A prolonged grind begins…

… It happened in the 1970s, when an oil embargo helped puncture the "nifty fifty" big-company stocks, and again in 2001, when the bursting of the Internet bubble caused a broad decline. Now, investors shaken by two days of severe volatility fear another bear market -- only this time, it would fully span the globe.

Even as some world-wide markets recovered yesterday on the back of the Federal Reserve's interest-rate cut, the losses have put some markets already in bear territory by the traditional definition of a 20% drop from a high.

The Russell 2000 small-stock index, bank-stock indexes and the Dow Jones Transportation Average already are down more than 20% from last year's highs. So are benchmark indexes from Switzerland to Taiwan to Chile.

The Nasdaq Composite Index fell 2.04% yesterday and now is 19.8% off last year's high. The Dow Jones Industrial Average is 15.5% below last October's record. Indexes in India and China are getting close to the 20% mark.

Some investors don't think a lengthy bear market is upon us. They believe the worst may be over as the Fed moves aggressively to prop up the U.S. economy. Yesterday, markets around the world bounced back, with London rising 2.9% and Brazil 4.5%. Tokyo shares were up more than 3% in trading this morning. The Dow Jones Industrial Average recovered significantly from big losses shortly after the opening bell, though it still finished the day down a little more than 1%.

Are We in a Bear Market?

The problem with calling a bear or bull market is that it’s a much easier call to make when you’re looking backwards; it’s often hard to determine a long-term trend when you’re in the middle of it. The other issue is that bulls sometimes exaggerate the value of positive data and bears can do the same with negative.

Looking at the data around stock market performance year-to-date, the question offered is this: how much of this is fear, and how much of it is a market readjustment based on valid economic woes, credit inflated profits, etc? Better yet, a bull market always has a degree of optimism priced in, and a bear market always have a degree of fear. The trick is to separate unjustified optimism from valid assessments of a company’s future, and fear from valid economic concerns. I think that in this market it’s hard to make those assessments by looking at various markets on aggregate. Instead, you have to look at beaten down sectors and find those firms that are being charged guilty by association, which leads us to the next topic.

Buying Opportunities

I’ve noticed that companies whose share price is being beaten down due to poor results will often show a slight pop after a bad earnings report, as people hunting for bargains snap up the shares in the hopes that the worse is over. A lot of beaten down companies will be purchased by investors based on the idea of “the company's such a well known name, are too big to fail, etc.” Such stocks become the top choice of the “lazy value investor.” These are people who buy stocks of well known companies because they’re monetarily cheap as opposed to a deep analysis of their future prospects/determining “cheapness” vs. fair value.

Meanwhile, similar companies that reported minimal issues, and whose stock is beaten down due to “being guilty by association” will show little movement, as the media/investors aren’t paying much attention to it. If you look at the analyst/media/blogger coverage of the financial sector the focus is on big names that are dealing with significant problems, not big names that have lost 30% of market value despite having relatively few difficulties, especially in comparison to their peers. These are the stocks to buy in a market like this one, relatively trouble free, stable companies that people simply aren’t talking about because scandal and big write downs are more exciting.

Call this post a subtle hint.

Here is an additional link to data looking at stock market valuations from 1999 to present, and a link to the original Wall Street Journal article.

Sources:

The Wall Street Journal: “Stocks Show Classic Bear Signals, And this Time, Impact is Global” – E.S. BROWNING and JOANNA SLATER – January 23, 2008.