Sunday, October 11, 2009

What is a Bear Market and Why Is It Good?

You might remember this recent post of mine.

http://cornholiogogs.multiply.com/journal/item/947/947

Talking about how young people do not trust investments in general. Young people are well , young. Meaning their experience is pretty much limited to the immediate. Although like I mentioned in that piece, even older people feel the same way. All because right now we are experiencing what has always happened since the beginning of recorded time. That is a bear market. Maybe you know the phrases bear and bull markets but don't know the origin of the terms. When a bear attacks you it is with downward motion from it's paws. When a bull attacks you it is with upward momentum from its horns. There you have it.

Nick Murray is a person who has helped me understand investments even though I am horrible at the execution part of it. I was fortunate enough to hear him speak back in the nineties.

Just understand a few basic principles that will eventually be elaborated on.

1) The long term values of companies will always go up long term and easily surpass any kind of cash or debt instrument.

2) The price of being in the best long term performing investment is the dips in value that you will see often during the life of the investment.

3) What good news can you get from the dips? Well your investments are on sale!! Buy more!

4) Is this understanding beyond your grasp? No!!

Ed


http://www.nickmurrayinteractive.com/articles/sample2009_four.html



THE FOUR ESSENTIAL CHARACTERISTICS OF ALL BEAR MARKETS

THE FOUR ESSENTIAL CHARACTERISTICS OF ALL BEAR MARKETS

This material is loosely adapted from my forthcoming book, Behavioral Investment Counseling. Bits and pieces of this material have certainly appeared, explicitly and implicitly, in this newsletter over the years, and will not be unfamiliar to longtime readers. They are collected, synthesized and offered here in the interest of rushing some more long-term perspective to the front lines in the current pitched battle against panic.)

A bear market, as I ve suggested elsewhere in this issue, is a period of time during which people who believe this time is different sell their common stocks at panic prices to people who understand that this time is never different. The very first truth of bear markets the perception after which we must order all our other perceptions is that all bear markets are fundamentally the same.

If and to the extent that this is true, the question then becomes: in what identifiable (and therefore predictable) ways are they all the same? What can we know about a bear market as we are going through it despite all its apparently unique terrors which will never fail to restore our perspective and defeat the urge to capitulate? I believe that there are four such immutable truths.

(1) Bear markets are an organic, natural, constant element of a never-ending cycle. The capital markets are capable of perfectly psychotic behavior -- constrained only by their capacity for emotional excess -- in the relatively short term (a year or two; rarely more). In the intermediate to longer term, the capital markets in general and the equity market in particular are powerless to do anything but reflect the underlying economic fundamentals.

And as long as human nature is the essential driver of all economic activity, economies will alternately cycle above and then below their long-term sustainable trendlines -- overshooting their capacities in optimistic expansions, and then undershooting them in frightened contractions. The dot.com bubble is an example of the former; the great unwinding of 2000 - 2002 the latter. The cheap-credit-fueled real estate/mortgage bubble of 2003 - 2005 typifies the former, and the current unpleasantness the latter.

Human nature being what it is, any economic enterprise worth doing is worth overdoing, and the capital markets must follow not just a similar but the same cycle of euphoria and panic. We have met the enemy, as Pogo Possum said all those years ago, and he is us.

(2) Bear markets are as common as dirt. We are currently struggling through the thirteenth bear market (which I and most others define as a decline in the broad market of about 20% on a closing basis) since the end of WWII. Thirteen episodes in 63 years seem to imply that they occur on an average of about one year in five (though with lamentable irregularity). At that rate, you ll see eight of them in a 40-year career of working and saving, and six more in the average two-person retirement.

One had better get used to them. Moreover, since their beginnings and endings are impossible to time, one had better develop the emotional maturity and financial discipline to remain invested through them.

(3) Equities great volatility is the reason for, and the driver of, their premium returns. Volatility does not, other than in the hyperbolic lexicon of catastrophist journalism, mean down a lot in a hurry. (Nearly four years in five, equities go up a lot -- quite often in a hurry -- but journalism somehow never characterizes such markets as volatile. ) Rather, volatility refers to the extreme unpredictability -- up and down -- of equity returns in the short term.

For example, you have not only never seen but cannot even imagine bonds providing a 20% total return in one year (through a combination of interest and price appreciation), and then posting a 20% negative return the next year. You would intuitively say that bonds just aren t that volatile, and you d be right.

Equities do it all the bloody time. Equities are that volatile. You just never know what they re going to do from one period to the next. And the premium returns of equities are an efficient market s way of pricing in that ambiguity. There are no good markets and bad markets; there is one supremely efficient market. And its way of dealing with equity volatility is to demand -- and get -- returns which have nominally been about twice those of bonds, and -- net of inflation -- real equity returns that are nearly three times greater. Premium equity volatility and premium equity returns are thus two sides of the same coin.

Take care then, in moments of great stress such as the current environment occasions, not to wish away the volatility of equities, because you are, whether you realize it or not, wishing away the returns.

(4) A bear market is always -- repeat, always -- the temporary interruption of a permanent uptrend. As I write, the broad market, as denominated in the S&P, is in the neighborhood of 1200, late in the thirteenth of these very common ends-of-the-world (for so each and every bear market is characterized by the media). The tippy-top of the market the night before the onset of the first of these thirteen cataclysms -- May 29, 1946 -- saw the S&P close at 19.3.

Think of it, dear friends: from the peak before the first bear to something approaching the trough of the thirteenth, stock prices alone (ignoring the compounding of dividends) have risen more than 60 times in about as many years. And why? Because earnings are up 60 times -- and, in this great golden age of globalizing capitalism, they are of course still going up. The advance is permanent; the declines are temporary. Always.

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But mustn t there be some way of defending capital against these horrific if transitory episodes? Must there not be some formula, some reliable strategy for taking capital out of harm s way? As a matter of fact, no.

Bear markets begin and end often, but not regularly: there is no consistent way of anticipating when an ordinary market correction will deepen into a genuine bear, nor when -- having done so -- the bear market decline will run its course. Peter Lynch wrote something to the effect that more money has been lost by people trying to anticipate and avoid bear markets than in all the bear markets themselves. (This is the equity market corollary of Paul Samuelson s observation that the consensus of economists had forecast nine of the last three recessions.)

Bear markets are so irregular and evanescent, and bull market advances so powerful and long-lasting, that trying to time the market becomes the ultimate fool s errand: it is a formula for long-term returns which are a fraction of the market s. Churchill famously said that democracy is the worst form of government ever formulated by man, except for all the others. Buy-and-hold is, in exactly the same sense, the worst equity investment strategy ever devised by man.

Except for all the others.

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