Shaky Hands?

A long time reader left a comment over the weekend expressing concerns about current events and what they mean. He is either starting to think or already does think that this bear market will be worse than normal. He cites many reasons to worry, says he is less confident about things and wonders how I can "cling to my faith" that this is a normal bear.

I responded with some numbers but wanted to reply in writing too with some of my thinking about the current situation and also my thought process in general.

One way to break this down is into two categories; facts and the things that people are afraid will become facts. As of Friday's close the S&P 500 was down 20%. It was a little lower earlier this summer and it seems like it will open a little lower today. Obviously no one knows where it will bottom out. Plenty of people have an opinion (including me; 1095) of course but that's all anyone has; opinion.

All the news of the last 18 months, SPX 1251 (as of Friday). That is a fact. The market might get much worse or it might not but what it might do is not fact. Even the news from the weekend, 1095 is still kind of a long way from here, not very far, but kind of. If the bottom were 33% (still close to normal) from the peak that would be 1049, that is a noticeable drop from here.

Before I go any further, let me say for anyone new I have been thinking we would have a normal bear market since before summer 2007, I said that I thought a bear had started on December 13, 2007 and have been consistent in thinking a normal bear would be about 30% down from the peak. As I began to write about my thoughts in this regard a commenter heckled me daily about my thoughts that a bear was coming--I was too bearish and now although I still have the same opinion some think, albeit much more respectfully and intelligently than the heckler, that I am too bullish.

Bear markets have certain sentiment based things in common, little truisms that repeat over and over. They repeat with such consistency that they are almost facts.

During every one of these big bad events that I have been through, I have been in the business since 1984, there is incredible fear about how bad this time is and the reasons why this time is different are always well reasoned and plausible. I have tried to make this point before and invariably a comment gets left telling me why this time really is different.

The fear is always bigger than the reality. One thing I am very good at is remembering how afraid people have been during other events. I can tell you the fear now is the same as it is every time. I also realize this point will fall totally deaf for some people.

Let me be clear about something which is that the context here is about what the stock market is doing. Whatever the deficit is doing, whatever the foreclosure numbers are, whatever houses are dropping, my job is to navigate the capital markets and in this post that is the only context.

For many months before the bear market started I described how bear markets start which is that the roll over slowly for several months (look at the chart in the post I linked to above), that an inverted yield curve (when they occur) is a reliable catalyst, that most talking heads tell us not worry, the bull is alive and all of this was the case for this bear. It has been so textbook that there is a humorous element to it.

Another part of normal is enormous failures; I'd say Fannie and Freddie fit the bill here.

There is a historical element that is also sentiment-based that leads me to conclude normal bear market which is the frequency with which the US market cuts in half. Typically there are decades in between 50% declines. This has been fact. The reason for this, IMO, is that once you go through a 50% decline you are so fearful of it happening that you sell before it happens. A 50% decline, again IMO, requires a new generation of investors who do not know this fear.

So in terms of the normal fear that now exists, the text book nature of the bear thus far, the big failures thus far and how recently the S&P 500 cut in half I conclude this will be looked at as having been a normal bear market. This is my opinion and so of course it could be wrong. Nothing has changed my mind but still none of the things I cited have to matter and again I could be wrong.

As many times as I have talked about my expectations for the bear I have also talked about having a larger cash position than normal, having some double short and remaining underweight financials throughout all of this with the goal of missing a chunk, not all but a chunk, of down a lot. You can look at the quarter end videos for the last couple of years to see how that has worked out.

This all as opposed to having no defensive plan ahead of time, left having to try to decide what should be done now after a 20% drop. So if I am wrong I feel as though the consequence of being wrong about the bottom is not that great, I am already defensively positioned and would get progressively more so if no other action is taken (the idea being SDS would hedge more portfolio as it went up in price).

As for general thought process the stock market goes up most of the time and occasionally it goes down in bear markets. The cycles repeat over and over with different details but similar results. This is an inevitability. Fortunately bear markets offer some warning ahead of time and heeding those warnings can add to the return over the entire stock market cycle which is a better measurement of time for people trying to accumulate enough money for retirement.

If bear markets are inevitable then as I see it there is very little to worry about, you know ahead of time they will come, you know this.

In terms of the US being somehow broken ok, but other countries are not broken. They may take longer than normal to come back but I believe many other countries are dealing with cyclical issues. If this turns out to be a secular issue for the US, ok, but the cycles in other countries will start to turn up. We need to have exposure to those countries whenever that happens.

Is this is shocking or new to anyone? Of course not.

Let me again reiterate that the context of this is the capital markets and protecting client assets as best as I can, not being right about how low the market goes or how bad anything else gets. I think that being correct directionally, which I have been and have shared on this site every step of the way, does a lot of the portfolio work. I will also reiterate that I could easily be wrong about where the bottom of this bear is.