We’ve been hearing a lot about bear markets lately. Let’s bring a Sensible Stock Investing perspective to the subject.
First, a definition of “bear market.” A bear market is a significant downturn in a major index such as the Dow. In standard parlance, a bear market exists whenever there is a 20 percent decline (or more) in a major index.
Technically speaking (that is, if you were looking at a chart), in a bear market the index’s value falls from a recent high. It crosses downwards through its 50-day moving average line, and eventually through its 200-day moving average line. The lines themselves cross too: At some point, the 50-day line crosses downwards through the 200-day line. This is called a “death cross.” At this point, the value of the index is below both its 50-day and 200-day moving averages, and the 50-day moving average is below the 200-day moving average. The chart looks like hell.
A bear market may be interrupted by “bear market rallies.” These are short-lived, often sharp moves upwards. They may occasionally bring the index value above its 50-day moving average, but not for long. Bear market rallies (also called “dead-cat bounces”) do not negate the overall downward trend of a long-term bear market.
Bear markets reflect–indeed they are caused by–falling corporate earnings, falling P/E multiples, and a negative attitude toward stocks. A bear market creates a headwind against stocks, and most stocks (around 60 to 75 percent) are affected eventually. Good companies as well as bad companies lose value, often for no good reason other than they are caught in the bear market.
In a bear market, there is negative investor sentiment toward stocks. The price declines and falling multiples reflect not only deteriorating financials but also a loss of faith and confidence in the stock market. Investors’ conviction about stock ownership turns unfavorable. An investor who has lost confidence in the stock market is “bearish.” He or she expects more bad news. Hope and confidence are replaced by fear and pessimism. Bearish investors become skittish, alert to any reason to “get out.” Scared investors lose their appetite for risk. Pessimistic investors keep selling until eventually the multiples go right down through normal historic levels.
Bear markets can last anywhere from a couple months to several years. Harrowing losses can frighten an entire generation. After the 1929 stock market crash, many investors became so afraid of stocks that they avoided them until the 1950s. It took 25 years-until 1954-for the Dow to finally close at a level it had first attained in 1929.
As the market cycles from the end of a bear market to the beginning of a bull market, individual stocks will “turn” at different times. This underscores the basic principle that the stock market is a market of individual stocks, not a monolithic entity where every stock acts the same.
What ends a bear market? The reverse of the things that caused it. An improving economy bolsters corporate earnings. Investors realize that that stocks of good companies have become bargains, and they move in to buy the underpriced stocks. Confidence begins to return, the desire to get back into stocks grows, multiples go up, and the bear market is over.
It is important to recognize that bear markets are trends within an overall upward bias in the stock market. This upward bias has brought the Dow from its 1929 level to over 12,000 today. Beware of the psychological mistake of being always a bull or always a bear. The Sensible Stock Investing view might be called “practical optimism”–a very long-term bullish conviction (based on history which shows that stocks have an unparalleled long-term record of success)-tempered by a recognition that business cycles create major and minor trends within the overall upward march.
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