The Nature of a Bear Market

Using criteria that I have developed to help clients understand when the US stock market is in a developed bull or bear market, I have come to the conclusion that we will experience a bear market in stocks in either 2016 or 2017. There are circumstances that can change this conclusion, but, until any such events occur, I am operating under the premise that we are in the final stages of a mature bull market (if the bear market hasn’t already started).

January has not started off well, but the finish is much more important than the start. I will give more direction on this at the end of this release. First, I want to share some of what I have learned through my experiences in managing through a bear market.

1. I define a bear market as a drop of 25% in stocks over a period of 12-18 months.

Bull markets typically last 5 years. From the time that this bull market began in 2009 until now, there has not been a bear market confirmation. If we rally back to the all-time high by March of 2016, the bull market will have lasted 7 years.

2. The last two bear markets averaged about a 50% net loss of each of the previous bull markets.

If we in fact confirm a bear market and do not make a new high, it is reasonable to expect the DOW to someday get back down to 12,500. This may scare some, but, if you are prepared, it should be seen as an opportunity. As most successful investors know, more money is made in bear markets than in bull markets (buy low!). It is too early to confirm a bear market, but understanding historical moves in the market and having a game plan is important.

3. Most firms on Wall Street are bullish on stocks.

The mutual fund industry makes money by investors staying in funds, so most firms will not provide guidance for a bear market strategy. I found this to be true in 2000 and 2008 at the past bull market tops.  I have kept research from 2008 as a reminder that the 10 major Wall Street firms forecasted the market to rise a mean of 11% in 2008, not to fall 39%. Most Wall Street firms turn bearish at market bottoms, which I also experienced in 2002 and 2009. In 2009, many firms turned bearish.  Most market forecasters on popular TV programs and media outlets do not manage money; they just state their predictions.

4) Stock market tops and bottoms are very hard to forecast.

No one is 100% accurate. Technical research helps provide guidance when markets are turning from an uptrend to a downtrend.

5) Most that are calling for bear markets today have been doing so since 2011.

Most that call for bear markets sell newsletters and books; they don’t manage money. There is a saying on Wall Street, “Fear sells”. Two weeks ago I read a lot of forecasts that were bullish for 2016; now most of what I read is bearish for 2016, including some predicting a 2008 market again.

6) Wall Street is dominated by emotions and opinions.

The majority of people that are warning about oil today (at $33 a barrel) did NOT warn two years ago when it was trading almost 3 times higher. Most financial decisions based on emotion do not fare well. If you liked Apple, for example, at $120 two months ago due to its balance sheet, etc., why wouldn’t you like it today at $99? Are you more likely to get a report today that Apple can go to $150 or to $70?

7) China was the “cause” for the stock market correction in August 2015.

The DOW had a massive rally in November 2015; what changed in China? China is back in the news today.

8) Last August we saw an extreme when the DOW dropped 2500 points in three days. What was your risk tolerance then?

Did you buy? If so, you have a high tolerance for risk. If you were very worried and questioned your portfolio risk, you may have too much risk. When the market rallied in November back above 17,500 and close to 18,000 did you or your advisor reduce risk (assuming you were worried in August)?

9) Volatility is constant during bear markets.

Corrections are steep, and rallies are steep. The best investors put money to work during steep corrections, and reduce risk on the strong rallies.   In 2008 the DOW Jones rallied more than 300 points on many occasions. Watching it daily can cause an emotional roller coaster. I have been through both the tech bubble and the real estate bubble and know that when the DOW drops 2000 points in a week, it has proven wise in almost every occasion to buy and unwise to sell.

10) Buy and hold is a strategy that works well for bull markets.

If you have the appropriate risk in your portfolio and a bear market is confirmed, buy and hold is very challenging without having a handle on your emotions.

11) Investors that make major mistakes in their portfolios, from my experience, make them in their late 50’s to 60’s, mostly because they have too much risk or too much debt going into retirement.

If you have enough to retire, stocks will always present a good opportunity if you are patient.

12) Always have perspective when you invest.

Is your goal 10 years from now, or is it 20 years from now? If you have financially reached a goal like retirement savings, the level of risk you take should be mitigated.

13) The use of alternative investments for high net worth clients (total net worth over $1 million) continues to rise.

Most alternative investments have less risk than the US stock market. If you haven’t taken the time to learn about these investments, make the time in 2016.

14) During times of turmoil in the stock markets, successful investors become more successful.

They separate themselves from the pack. Most investors assume that most money is made during bull markets. This is not true. Just as most NFL teams win with superior defense, so too do successful investors learn to navigate the emotions of the bear market. The reason that the majority of investors fail is that they make poor decisions when the market fails. When it is time to be overweight in stocks, most investors do not want to be.

Have the criteria been met for a new bear market?

The answer is, not yet. I continue to hold the possibility of one last rally, though our clients know that I am and have been cautious since last summer. Here are some conditions to watch for in this final phase.

1) We must rally strongly by the end of the month. The DOW needs to rally back above 17,000 at a minimum, preferably back above 17,500.

2) If 17,500 is recaptured, it should not be breached again.

3) Failure to do the above, or a continuation of the DOW below 16,000, would give further credibility to the idea that the US stock market is now in a confirmed bear market. If this occurs, the DOW would most likely drop back to the August low of 15,370 before a sustained rally.

4) If confirmed, the new bear market should last about 18 months (May 2015 would be the actual start).

In conclusion, stocks and bonds have not been kind to investors in 2015, and now the start of 2016 has been rough. The best direction one should take is to not panic, to re-assess risk, and to be prepared.  During bear markets there are always significant rallies to reduce risk, if you feel you should.  A bear market can be seen as a great opportunity, if you can work through the emotions of investing.