They Call This a Bear Market?

I have been seeing some compelling arguments that the bear market is close to its completion. The central points to the argument are: 1) the vast amount of bearish sentiment out there, 2) high cash levels, 3) the majority of investment newsletter being bearish in tone, 4) a high put/call ratio, 5) market valuation and 6) the Bear Stearns bailout/rescue/plunder. Market bottoms are often marked with a dramatic cataclysmic event and some commentary suggests this time around it's this Bear Stearns deal.

As I have said before, the problem with the concept of a bear market is that one can only determine whether or not we have experienced a bear market after it has already happened. So, by the time the bear market is confirmed it's too late to do anything about it. The idea that one could sell stocks at the peak, hold cash through the bear market and then re-enter the market just as the bear market is ending is, in my view, pure fantasy.

So, before we try to figure out what's going on right now and what to do about it, let's take a quick look at the past. We can all agree that the latest bull market began in late 2002 or early 2003. From that time to the peak in October of 2007, the market (I use the S&P 500 Spider -- ticker symbol (SPY) -- for my "market" analysis because that's a security you can actually buy if you want to "buy the market") rose more than 90% -- a great return for a 5-year holding period (a compound annual return of roughly 14%).

During this bull market, I identified seven "corrections*" where the market fell 3% or more that would have been attractive entry levels for believers in the bull market. It's interesting to note that probably on every one of these corrections, somebody out there started to call into question the status of the bull market. With the perfect clarity of hindsight we can see that simply holding the market over this time would have been hugely profitable and that buying on dips was also generally a good idea.

Now, let's take a look at the current bear market (assuming for a minute that it is indeed a bear market). From the October 2007 peak to the March 2008 low, I calculate a decline of about 18% (I use closing prices in all my price analyses). Technically, a bear market is one that falls 20% but I am sure most investors felt like it was a bear market on March 10th.

During this time, I have identified eight "bear market rallies" of 3% or more so far in this cycle**. This suggests that an investor using a simple buy and hold strategy from October 2007 to now would see his or her portfolio down about 12%. I think the reader can see the value in trading more in a bear market, and using the market volatility to one's advantage. Also note that in the 5-year bull market we saw seven dips to buy. In this 5-month old (young?) bear market, we have already seen eight rallies. Generally, selling the peaks is the better tactic in a bear market.

I am not really sure that we have seen the bottoms yet in this cycle and I am continuing to manage my portfolio accordingly. Yet, I am loathe to make any kind of prediction and would be much happier in many ways if we entered a new bull phase. Time will tell...

Please take another look at my blog here about investing in a bear market.

I have been trading a bit more recently and I think I will continue to do so.

Please take a look at my private blog for the details of the telecom stock trade I recently did and other trades I might do in the near future.

* Here are the bull market corrections as I calculated them:
1) Late ?02 to March ?03 -9.8%
2) early 2004 -3.5%
3) later 2004 -3.2%
4) early 2005 -4.1%
5) later 2005 -2.9%
6) mid 2006 -3.2%
7) mid 2007 -5.0%

** Here are the Bear market rallies as I see them
1) Oct 19-Oct 31 +3.3%
2) Nov 12-Nov 13 +3.1%
3) Nov 26-Dec 10 +7.9%
4) Dec 17-Dec 26 +3.1%
5) Jan 22-Deb 1 +6.8%
6) Feb 6-Feb 28 +4.0%
7) Mar 10-Mar 11 +3.6%
8) March 17-Mar 25 +5.1%

Comments

[tradersyste...:]

Interesting comments. You are certainly not the first to proclaim an end to the bear market. But each one of the indicators with the exception of the last are very short-term and also indicate the beginning of a bear market rally... Would love to see your research showing that valuations show a bottom. All my research indicates that valuation metrics like 3-month trailing and forecasted PEs have a poor record in helping anticipate turnarounds...

Challenges with the bear market is about to end hypothesis are;
1) It is heavily dependent on what happens in the real estate market and given that real estate cycles are 18.5 years long and have only been contracting (price) for little more than a year, would seem to point to the fact that we are still early in the correction phase.
2) We have just come off the top of the largest number and scope of asset bubbles in history. As Jeremy Grantham pointed out some months ago, such events have ended neither quickly or without significant pain in the past and take years not months to run their course.
3) If you buy into the valuation argument, Robert Shiller who uses trailing 10 year PEs says that current valuations around 20 are anything but cheap. Corrections in the past have seen valuations drop below 10 before the cycles turns back up.
4) Most of the major sectors (financials, auto & truck, RV, retail and banks) that turn down in advance of the S&P500 in a recession are still heading lower. This does not suggest that a sustained turnaround is in the offing anytime soon (see tradesystemguru.com/co... ).
5) Economic indicators continue to show deteriorating conditions such as consumer spending, durable goods, consumer sentiment, jobs etc. While many tend to lag, a number have just begun to turn down and once begun, these trends do not generally reverse quickly.

In other words, while I agree that we could be near to the beginning of yet another bear rally, I see little evidence of major reversal in the cards anytime soon.

Matt Blackman - TradeSystemGuru.com

2008 Mar 27 12:46 PM

[Gross Bill:]

Ummm, we just finished a bear rally...from 1276 to 1350, you think it's going to shoot up again from here?

I say it drops through 1270 this time with the added weight of bad earnings and the recession that few have really accounted for.

2008 Mar 27 08:18 PM

[matt...:]

I have a hard time believing this is the end of yet. The media hasn't even acknowledged that we're in a recession! We haven't seen any capitulation by the bulls, they keep trying by can't get the party started again.

2008 Mar 27 09:58 PM

[GKM:]

The historical terminus of a bear market has been when the S&P reached a p/e of 8. I believe we are still at about 18. While I can make a case technically for a retracement to higher levels from here, it is doubtful that we've seen the lowest levels yet.

We did hit the 38.2% Fibonacci on the SPX perfectly but in terms of proportionality for time, we are no where near what could be expected. Who knows. If we do rocket higher from here, then I'll definitely be very long of gold miners and oil and gas since the only way that is happening is if things are so inflated as to look cheap. The only money will be real money and it will be $3000 per ounce.

2008 Mar 28 12:25 AM

[cynic69:]

This "rally" has no volume. The only folks who are buying stocks are the guys watching the talking heads on CNBC like Larry Kudlow. Kudlow is wrong on the economy, wrong on the environment and wrong on the stock market. After the individual investor has been led to slaughter the institutions are going to hit the sell button to completer the job. The high price of energy is going to insure that consumers stay away from the malls. That one fact is enough to torpedo any kind of economic reversal.

2008 Mar 28 11:53 AM

[feste:]

The bottom of a bear market is when the last thing anyone wants to do is own stocks.

2008 Mar 29 02:09 AM