Stages of a Bear Market ~ market folly

Thursday, January 22, 2009

Stages of a Bear Market

Stewie outlines the stages of a bear market:

"Stage 1. Distribution

Just as accumulation is the hallmark of the first stage of a primary bull market, distribution marks the beginning of a bear market. As the "smart money" begins to realise that business conditions are not quite as good as once thought, and thus they begin to sell stock. There is little in the headlines to indicate a bear market is at hand and general business conditions remain good. However stocks begin to lose their lustre and the decline begins to take hand. After a moderate decline, there is a reaction rally that retraces a portion of the decline. Hamilton noted that reaction rallies during a bear market were quite swift and sharp . This quick and sudden movement would invigorate the bulls to proclaim the bull market alive and well. However the reaction high of the secondary move would form and be lower than the previous high. After making a lower high, a break below the previous low, would confirm that this was the second stage of a bear market.

Stage 2. Movement With Strength

As with the primary bull market stage two of a primary bear market provides the largest move. This is when the trend has been identified as down and business conditions begin to deteriorate. Earnings estimates are reduced, shortfalls occur, profit margins shrink and revenues fall.

Stage 3. Despair

At the final stage of a bear market all hope is lost and stocks are frowned upon. Valuations are low, but the selling continues as participants seek to sell no matter what. The news from corporate America is bad, the economic outlook is bleak and no buyers are to be found. The market will continue to decline until all the bad news is fully priced into the stocks. Once stocks fully reflect the worst possible outcome, the cycle begins again."

Based on the above descriptions, it would seem as if we are somewhere in the midst of Stage 3. The problem is, this stage could last a pretty long time. There's a ton of cash on the sidelines now, and many assets are cheap. But, that doesn't mean they won't get even cheaper. Everyone realizes we are in a recession now and the economic outlook is definitely bleak. So, the question becomes: how much more despair lies ahead? We'd say a decent amount, as it will take a while for America to work through the bad taste in its mouth. The whole process is only natural, though. And we'd also like to remind everyone that while there is panic to the downside, there is also panic to the upside. People don't want to miss out on "the bottom" when it finally comes.

blog comments powered by Disqus