Jan

26

VictorThere has been much talk recently about the many bear markets that have been achieved. The way it's usually defined is that a market has declined 20% from a recent peak. There are many ways of quantifying that, but let's say the definition is that the current month's close is less than a monthly close in the last five years by more than 20%, and is also not more than 10% above a close preceding it in the last five years by 10%.

In November 1968 the S&P 500 closed at 108 and in January 1970 it closed at 85. Subsequently the S&P 500 rose, to 118 on December 1972, then fell continously to 64 in September 1974. It then rose continously to 1400 in December 1999 and then fell to 815 in September 2002.

During 1929 the market rose to 31 in August, then fell to 4.8 in June 1932. In June of 1921 there was a 40% drom from tge high of 10.2 in 1916. Those are the only major drops.

There are many questions. There were three declines of more than 40%. Were these offset by the many drops of 20% that bounced back? Have conditions changed since 1929 when the market dropped by 83%? What would proper exit and entry points be? What happens when the market drops by 20% within various periods? How does the interest rate environment affect it? Have declines associated with big drops in real estate been any different? is there such a thing as a bear market?

Rudolf Hauser adds:

Rudy HauserI have always looked at the bear markets that ended in 1970 and 1974 as two distinct bear markets. What characterized both the major periods of down markets in the 1930s and 1970s were inappropriate monetary and other government policies. This is what appears to turn modest periods of market and economic setback into major ones. In the 1930s monetary policy was too restrictive and other government policies were also the absolute wrong way to go. Because these mistakes were on the downside of economic policy decision making, I have tended to view that as one protracted bear market interrupted by a rally. Following the 1970 episode the Fed was much too expansive, which compounded the underlying inflation problem. That in turn led to the 1973-1974 debacle and subsequent ones until this stop-go policy finally ended under Volcker and Reagan. The lesson seems to be that market downturns caused either by market (not just equity markets) imbalances and/or mistaken government policies may remain moderate unless further government mistakes in reacting to the events are badly mistaken ones. One just has to hope that the government and central bank have learned from past mistakes and do not stumble into some new variation of mistaken policies. If they can do that the prospects for the equity markets are much better. The low probability major downside risk I see here is the whole structure of derivatives and other new products that spread out risk to those willing to bear it. The problem comes if enough of those ultimate risk takers are not able to bear it and take down those who lent to them and those who were counting on their ability to pay up when the time comes. If this goes into major financial institutions that are not just short of liquidity but suffering from major negative equity positions that cannot be baled out without special government legislation, we could have a new version of mistake — one that perhaps cannot be blamed on government actions as opposed to inaction, unless one wants to place the blame on monetary policy that too expansive in the past for asset markets.

Jim Sogi remarks:

Jim SogiThere are many ways of quantifying a bear market.

For the sake of argument, let's call it a one or more down months. Looking at Dow monthly from 2/1945 to 11/2006, 309 months were down and 424 were up.

If we say two or more down months in a row is a bear market then we have the following count of consecutive up and down months. Under this definition we are 40% of the time in a bear market. Three down months are close to 40%.

Months in a row, down, up

2 39 50
3 21 32
4  4 11
5  2  3
6  4  6

If we look at first 360 months the situation is much darker with close to 50% of the time in a down market.

2 20 20
3 11 17
4  2  6
5  2  0
6  2  3
7  0  1
8  0  1
11  0  1
12  0  1

The last half is brighter, but there are a number of downdrafts.

2 19 30
3 10 15
4  2  5
5  0  3
6  2  3
7  0  1
8  0  1

So yes, there are bear markets. Lots of them.

As to magnitude: mean down month is -80.8, mean up is +84.2

This shows the drift, but also that the downs months can be bad. This study highlights the skew in the data.


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