Bear Markets Are Dangerous
Has the bear market started?
In my recent post, I explained the reasons why I think the Bear Market is Starting. This is a prediction based on fundamental and technical reasons that have served me well in the past.
From a purely technical perspective, it's too early to tell whether the bear market has started. For a confirmation, I look at the 200 day simple moving average. If the index stays below its 200 day moving average for 6 months, then we're in a bear market. Conversely, a bear market ends when the index stays above its 200 day moving average for 6 months.
This is a great method to identify bull and bear cycles, but it's not predictive. You cannot trade the index using the above criteria; by the time you notice a transition, the price has moved a lot. So then what's the point?
The above criteria is great for painting a picture and orienting you to where you are in the market cycles. There's value in knowing where you are. Why? Because...
Bears are dangerous!
Bear markets are bad periods to invest in. There are sharp drops, volatility, and systemic instability with far reaching consequences beyond the stock index. These are periods where many companies go bankrupt, because rough periods in the market expose all the problems and scandals that accountants and executives have been covering up for the past years.
It's worth knowing if you're in a bear market, because you can then take more defensive steps. Bear markets are the times when stocks crash to zero. If you use leverage, bear markets are when you get destroyed. To be blunt: bear markets are when lives are ruined.
Recalling the 6 month delay from the above criteria, we find that the two prior bear markets were identifiable by: April 2001 (for the 2001-2003 bear) and June 2008 (for the 2008-2009 bear).
Let's look at why this is so important.
Here's a list of the 22 largest bankruptcies in world history. The table below summarizes all the bankruptcies since 2000. The "During bear" column indicates whether the collapse occurred during an identifiable bear market, after the date that our criteria can detect it.
|Pacific Gas||April 2001||YES|
|Global Crossing||Jan 2002||YES|
|UAL (United)||Dec 2002||YES|
|Delta Air Lines||Sept 2005||no|
|New Century Financial||April 2007||no|
|Lehman Brothers||Sept 2008||YES|
|Washington Mutual||Sept 2008||YES|
|Lyondell Basell||Jan 2009||YES|
|General Growth (GGP)||April 2009||YES|
|Thornburg Mortgage||May 2009||YES|
|General Motors||June 2009||YES|
|CIT Group||Nov 2009||YES|
These bankruptcies wiped out billions of dollars of investor money. The publicly traded stocks crashed to zero. 79% of these collapses happened during bear markets.
Counting by dollar values, the companies which collapsed during bear markets account for an incredible 94% of the total!
This shows how nearly all the investor money was lost during the bear markets, after the date that our simple criteria can detect the bear market in progress.
Identify bear markets and act defensively
Use the criteria described above, with the 200 day moving average, to identify bear markets. If you find yourself in a bear market, take steps to reduce your risk:
- Reduce leverage
- Ditch investments with any air of fraud, bankruptcy, or scandal
- Be extremely cautious of weak stocks; they may go to zero!
- Avoid exotic, suspicious investments
- Realize that bankruptcy risk is very high
Most investors miss the point of why we try so hard to identify bear markets. Investment risk isn't just about a declining S&P 500 index value or the risk of inflation. You can go along many years with moderate returns, and then suffer one giant blow-up that sets you back many years. This happens alarmingly often during bear markets.