As you are likely aware, I've been at this game for a fair amount of time now. Starting in the financial services business straight out of college in 1980, I began gravitating toward the stock market and by 1987 my colleagues and I were managing "OPM" (other people's money) on a discretionary basis. As such, my first introduction to a bear market was very early in my career.
Needless to say, the "Crash of '87" and the ensuing volatility over the next few years shaped my thinking about the need to manage risk in this game. And to this day, I view myself first and foremost as a manager of risk.
I bring this up on this fine summer Tuesday because stock market investors have enjoyed the second longest period in history without a -20% decline. Heck, this is also one of the longest stretches without even a -5% correction. So, using history as a guide, the key point I'd like to make this morning is simple. The bears are due.
The problem however is that trying to "call" a bear market in advance is a fool's errand. First, it is important to understand that they just don't happen very often. And second, please note that there is generally some sort of catalyst to get things moving in earnest to the downside - a "trigger" that most don't see coming.
So, this morning I'd like to share some of the things I've learned about the bear markets I've experienced in my 30+ years of managing money in the stock market.
For starters, long-term investors should remember that bear markets tend to be few and far between. During my career, the bears took control in 1987, 1990, 1998, 2000-02, 2008, 2011, and then most recently between August 2015 and February 2016.
Below are some of the key things to know about bear markets.
- Per Ned Davis Research, there have been 36 cyclical bear markets since 1900
- According to NDR, 14 of the bears occurred during secular bull phases (such as 1982-2000 and 2009-present), and 22 within secular bear cycles (examples include 1965-1982, 2000-2009)
- The average loss experienced by the Dow Jones Industrial Average during all bear markets is -30.6%
- The average duration of all bears has been 399 calendar days (or about 13 months)
- During the secular bull cycles, NDR tells us that bears are less severe (the average decline is -21.8%) and much shorter (283 calendar days)
- So, the good news is that, using history as our guide, the next bear market ought to be shorter and shallower than average
- In terms of how bears begin, it is important to understand that bull markets tend to last longer than expected (especially for those in the bear camp)
- The internal momentum of the market historically peaks long before the indices
- Very few see the ultimate top happening (except for the "boy who cried wolf" types, of course)
- Market leadership tends to narrow as bull markets age (this explains why active mutual fund managers struggle to outperform - especially during latter stages of long bull markets - and why passive investing becomes uber popular as bulls age)
- Technical divergences tend to occur among indices, sectors, styles, etc.
- Earnings expectations for the coming year are usually robust near the ends of bull markets
- Economic growth tends to be sound with "no one" calling for recession
- Volatility tends to be low and investors begin to believe that stocks can't go down
- The public tends to be completely onboard the bull band wagon
- Stock market valuations don't matter - until they do, and then they matter a lot
- The Fed usually gets their way
- Rising rates represent competition for stocks - Again, at some point (or in this case, at some level), this matters
- Stock market cycles don't repeat exactly, but the do often "rhyme"
- Investors tend to be ready to "fight the last war" (I.E. the cause of the next bear market usually has nothing to do with the last one)
- External events - events that no one anticipates - happen
- Bear markets tend to occur when no one is looking for them
- The definition of investing genius is "a short memory in a bull market"
To be sure, the above is not an exhaustive summary of how bears work and/or begin. However, I find it useful every now and again to remind myself of how many bears have unfolded in the past.
I'd also like to make it clear that I am not "calling" for a bear market to begin. But given that (a) valuations are high, (b) rates are on the rise as global central bankers end their stimulus cycles, (c) stock market momentum has peaked, (d) the cycle projections are calling for a decline in the second half of the year, and (e) the last 20% decline is now a long time past, I don't think it hurts to recognize that risks are elevated and that perhaps this is not the time to have the pedal to the metal in one's portfolio.
The good news is that the secular bull remains intact and therefore, a "buy the dips" strategy continues to make sense.
Thought For The Day:
It is possible to train your mind to see the good in everything.
Current Market Drivers
We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).
1. The State of the U.S. Economic Growth (Strong enough to justify valuations?)
2. The State of Earnings Growth (Ditto)
3. The State of Trump Administration Policies
Wishing you green screens and all the best for a great day,
David D. Moenning
Chief Investment Officer
Sowell Management Services
Disclosure: At the time of publication, Mr. Moenning and/or Sowell Management Services held long positions in the following securities mentioned: none. Note that positions may change at any time.
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