Yesterday's post where I ragged on just about everyone was heavily commented on both here on on Seeking Alpha. I realized that I left out an important (to me) point that probably should have gone near the part where I picked on Larry Kudlow, Art Laffer and Brian Westbury.
There seems to be a failure to acknowledge that bear markets are a normal part of the stock market cycle. This failure is common to many people and is beyond me. The stock market goes up most of the time but sometimes it goes down, simple as that. This will repeat over and over because it is normal and just how things work.
As 2007 was winding down the bull market was about five years old. The risk of a bear market is greater after a five year bull market. This conclusion can be drawn without any awareness of the current condition. That would not be sufficient to declare that a bear market was here but in terms of risks, the risk of a decline would be greater after a run up that lasted for five years.
In the early days of this blog long before the bear market and financial crisis started I wrote often about mentally preparing for a bear market. I wrote about how they almost always start. They start slowly and most people do not recognize them for what they are and deny a bear has started which ties in with the perma-bulls somehow forgetting how normal bear markets are to the stock market cycle.
Then sure enough the bear market started slowly back in Q4 2007 and of course most people denied it. The textbook start (I chose the word textbook there because I relied on history to be my guide) to this bear made it, IMO, easier to spot.
If you think about bear markets ahead of time and realize they are simply a part of every cycle then you are less likely to react with emotion, you are more likely to have a plan in place for defense (if that is appropriate for you to do). Then when the time comes you only need to be disciplined enough to execute the plan.
Maybe we can blame the failure of some to even acknowledge ahead of time that bear markets are possible (not even talking about a reasonable prediction, just the acknowledgment that a bear will come one day) on various biases, conflicts and constraints but none of that needs to apply to you. If we are to conclude that your fund manager, for whatever reason, will not protect your assets then you need to take it upon yourself. The next bear market, whenever it comes, will start very similarly to this one and the ones before it.
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18 comments:
I read recently that until the 1990s/early 2000s on average there was a bear market every five years. In reading the Graham's Intelligent Investor, a table of high/lows is presented going back into the 1800s illustrates just that. It is the reason stocks have a higher risk premium than just about other asset class. About the only way to exploit this cycle is to lighten up when valuations are high and to purschase when valuations are lower. I highly recommend the book to all the regulars who comment here, even if you don't agree with buy and hold. There is ton of plain old timeless wisdom.
Bear markets transfer ownership of companies from speculators to investors. For every seller, a buyer. What's troubling is lately the only buyer for financials seem to be Uncle Sam. As has been said before, "This too shall pass."
Maybe it was a matter of thinking things have changed?
For example, people used to say " you need small caps 'cause historically they've outperformed over the long term." Now I'm starting to read that small caps no longer outperform over the long term since everyone already knows this.
Hi Roger: Here come ETN's on the VIX,perhaps as early as this week. http://www.marketwatch.com/news/story/Investments-based-fear-index-creating/story.aspx?guid=%7B285B385F%2DA53D%2D46F7%2DAAAD%2D9F02B5823635%7D
Aside from the potential counterparty risk (or perhaps that is too big of an aside), am wondering what your and your reader's thoughts might be as to their potential use......
Andrew
i wrote about the VIX ETNs here
oops, THANKS
If your definition of a bear market is one that is down 20% then I concur. But this bear market is not a normal part of the stock market unless you broaden your definition to crashes, depressions and near depressions.
We are closer to depression than anyone can imagine. This year will make 2008 look tame. The S&P will see 600 and worse. Obama is taking a page from Roosevelt because he knows history repeats itself. And we all know what happens when history is ignored!
in terms of a catalyst for taking defensive action the things I focus on do not warn of magnitude they simply warn to reduce exposure. I am not worried about trying to be correct about magnitude. Bear markets warn early, heed that warning and being right about magnitude becomes far less important.
from anon 8:32
I believe I understand your explanation. When does magnitude become part of your reasoning?
After all, you can take a defensive posture based on your analysis for a 20% drop, but stocks then dropped another 30%!
no, the market warned it was in trouble when it went below its 200 DMA. look at how little the market was down at that point--nowhere near 20%. That was a trigger for defense, period. In my case that meant raisign some cash and adding a double short ETF. there needs to be, and was in my case, then a subjective assessment of whether then more defense action was in order, I felt there was and disclosed what I did along the way. if you raise a bunch a cash, understand what sectors are likely to lag and which ones are likely to do ok, relatively, then why do you need to be correct about the magnitude? too many people, imo, focus on the wrong thing. Being right about the magnitude ensures nothing, the moves you make determine the result.
taken to the extreme. if you went 100% cash on Nov 1, 2007 expecting a 20% decline does it matter that 20% was wrong?
from anon 8:32
I got it. Thank you. I didn't realize that you used a double short like a DXD. I must have missed class that day!
Seriously, your two explanations are clear, easy to understand and certainly make sense. Reminds me of Rukeyser, r.i.p. His show today would have been THE show to watch.
Thanks again.
Did Ruckeyser (R.I.P.) ever meet a stock he didn't like? I seem to recall he was a permabull and therefore would have been for fodder for the slaughter.......or did I miss something all those years?
from anon 8:32
Rukeyser spoke to the common man. The guests were mostly bulls. His show would have been very interesting in in 2008.
Excellent quote by Buffet:
http://www.kiplinger.com/magazine/archives/2009/02/discovering_value.html
"...No argument there, but the near-term economy shouldn't be the main driver of any stock-buying decision today. That's because it's so difficult to assess how that economic state will actually translate into stock prices. As Warren Buffett put it in a New York Times essay last October: "I haven't the faintest idea as to whether stocks will be higher or lower a month -- or a year -- from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over."
I came across this article with Roubini today on Bloomberg:
Jan. 27 (Bloomberg) -- "Global stock market declines are increasingly correlated and emerging economies will follow developed nations into a “severe recession,” according to New York University Professor Nouriel Roubini.
Roubini said economic growth in China will slow to less than 5 percent and the U.S. will lose 6 million jobs. The American economy will expand 1 percent at most in 2010 as private spending falls and unemployment climbs to at least 9 percent, he added.
“There is nowhere to hide,” Roubini, an economics professor at NYU’s Stern School of Business who predicted the financial crisis, said from Zurich in an interview with Bloomberg Television. “We have for the first time in decades a global synchronized recession. Markets have become perfectly correlated and economies are also becoming perfectly correlated. This is not your kind of traditional minor recession.”
Roubini said the U.S. government should nationalize the biggest banks because losses will exceed assets, threatening to push them into bankruptcy. The banks could be privatized again in two or three years, Roubini said. The professor reiterated his prediction that U.S. financial losses will more than triple to $3.6 trillion and that global equities will fall 20 percent this year from current levels.
‘Zombie Banks’
“Nobody’s in favor of long-term ownership of the U.S. banking system by the government, but if you don’t do it this way, you end up like Japan where you kept alive for a decade zombie banks that were never restructured,” he said. “That’s going to be much worse. It’s better to clean it up, nationalize it and sell it to the private sector.”
Japanese policy makers hesitated in addressing a banking crisis in the 1990s and then struggled to revive growth and fight deflation in what is known as the “Lost Decade.”
Roubini recommended holding cash or short-term government debt and said high-yield bonds are cheap relative to U.S. stocks.
In July 2006, Roubini predicted the financial crisis. In February of last year, he forecast a “catastrophic” meltdown that central bankers would fail to prevent, leading to the bankruptcy of large banks with mortgage holdings and a “sharp drop” in equities. Since then, Bear Stearns Cos. was forced into a sale and Lehman Brothers Holdings Inc. went bankrupt, prompting banks to hoard cash and depriving businesses and households of access to capital."
Hey Roger- what is your take on this interview with Roubini. I will paste a snippet however he expects a hard landing for China and favors Turkey. Do you have any opinion on the latter country?
http://www.rgemonitor.com/blog/roubini/255304/interview_on_the_us_the_global_economy_and_turkey
"Ipek Cem: You just mentioned emerging markets, and clearly it is a big component of the global economy, especially economies like China, India, Brazil, and I know that you did a lot of work observing the crisis in emerging markets in the 90s which gave you alarm about a possible collapse in the US. Every economy is different, so you could go country by country... What are your views on some of the major emerging markets and how they are handling their crises?
Nouriel Roubini: Well, the first observation is that of course emerging markets have been affected by this U.S. and European economic and financial crisis because, you know, when the U.S. sneezes the rest of the world catches a cold, and in this case it is not just sneezing, it has a severe case of pneumonia, so the financial contagion unfortunately has been large, and the trade channels, the financial channels and others imply negative effects on growth of emerging markets. Of course some emerging markets have better policies, better institutions, better fundamentals. They'll have a bad year, and they're going to then recover, and I would put Turkey among the countries that is in a stronger shape, compared to other ones, but the are other ones that have made major policy mistakes, are much weaker, and some other countries could have outright, severe financial crisis. Some among the major emerging markets, I would say, Russia will have a very large recession this year because with all energy prices so low will be a recession. A country like Brazil, also, going to have very weak economic growth, because they depend on commodities. So the commodity exporters are going to be hurting because of the fall of commodity prices. Some emerging markets, like Turkey, are commodity importers, but some of these countries have large current account deficits, they need their capital and borrowing from the rest of the world to finance their government and their external debt, so... and then they are also linked to trade links to Europe and other countries, so for some of the commodity importers lower commodity prices is good news, but then less exports to Europe, U.S., and tighter financial conditions is bad news. So emerging markets different depending on what are the conditions.
Ipek Cem: What about China, India... these countries?
Nouriel Roubini: I worry about a hard-landing in China. For China is used to grow 10% per year. I predict growth of 5%. I mean other countries 5% looks good, but for China it's a hard-landing, because China needs a growth rate close to 10%, to move every year about ten million poorer rural farmers to the modern, urban, industrial sector. So China's growth of 5% or below is effectively like a mini recession. So that's going to be a very painful thing for China, and I expect that actually China is so dependant on exports to the U.S. and other countries that this fall in demand for their goods is going to have a very negative effect on its economy, and already the latest data suggests that, you know, India is less dependant on trade, but there is fiscal problems. The Government is too large, structural rigidity, current account deficit, needs to borrow from abroad and therefore the shock is going to be transmitted through the credit crunch.
Ipek Cem: You just mentioned Turkey as one of the emerging market actors which could have a softer landing, let's say, or a better recovery than some of the severe cases. I know you have been following Turkey even in your blog in the RGE Monitor. What is your view on Turkey?
Nouriel Roubini: Well, my view on Turkey is that certainly compared to 2001 when you had a very severe economic financial banking crisis, the overall market and financial outlook is much stronger. You have had the primary surpluses and the fiscal condition of the Government is much better. Independent central bank with trying to achieve inflation stability. You have cleaned up your financial system. The banks have much more capital and liquidity. They have less of those mismatches that caused trouble. The supervision and regulation has become much stronger. So the overall framework is there and all these reforms has led to growth, and growth of exports and competitiveness and so on. So the framework from which you started is stronger one. Of course through trade and financial links Turkey is related to global economy when the demand for Turkish exports falls sharply from Europe and other parts of the world, then that's a negative for Turkey when there is that amount of capital available, and cost a bit higher then Turkey has to finance its external debt. It has to roll over the debt of the Government, the debt of corporates. That becomes more difficult. So this current account deficit, and the debts of the private sector, corporate or the Government is always an issue that you have to address. The currency had become, in the past, too strong, is now starting to weaken. That's good news for exports, but in a global economy that is weak then export growth is going to be weak. The value in local currency of foreign debts in foreign currency of the corporates is going to rise. That's a negative. So it's a difficult time for Turkey, I can say."
Anon 7:54- thanks for the link to Roubini. I found this part interesting:
"Ipek Cem: I know you are not investing in stocks, but how would you allocate a portfolio at this point in time?
Nouriel Roubini: For the next six months I would be just cautious, you know, I think that people for recently they thought that the worst is over, that maybe people can go back into equities. There was a bit of a rally in November, December, but the last couple of weeks, in January, things in the economic news have come out much worse than expected. We have realised many even of the biggest banks in US, they need even more capital of the Government. So I think that overall the flows of news about the economy, about profits, about financial systems, are going to be worse than expected, and that's going to be negative for equities and for other risky assets. So for the time being I will be cautious and stay in the safety of cash, cash-like instruments, safe Government bonds, and only when we see more clearly that there is a light at the end of the tunnel, we are getting out of this tunnel of economic and financial crisis, then of course there will be a more sustained recovery of equities, and of other types of assets, but you know, for the time being, I will be more on the cautious side."
754- here is Roubini's take on Turkey:
"I would characterize the strengths and vulnerabilities/risks of Turkey as follows:
Strengths:
· Government committed to macro/structural reforms
· Large primary surplus and low fiscal deficit
· Falling public debt to GDP ratio
· Falling oil prices reducing the current account deficit
· Flexible exchange rate and falling currency value increasing competitiveness
· Strong financial system (banks well capitalized and liquid and without currency mismatches) that in much better shape than in the 2001 banking crisis
· Much better supervision and regulation of the financial system
· Likely negotiation of a new IMF program that will provide a buffer of liquidity ($20-25 billion)
· Falling inflation allowing the central bank to cut policy rates more aggressively
· Room for a modest fiscal stimulus as the primary surplus is sizeable
Risks/Vulnerabilities
· Falling exports as the global recession takes a toll on the country’s exports
· Negative effects of the global credit crunch and liquidity crunch on the quantity and price of credit
· Still large – if falling - current account deficit
· External deficit increasingly financed by short term debt rather than equity/FDI
· Risk of a sudden stop of capital and reversal of capital flow
· Relatively low level of forex reserves compared to financing needs
· Large foreign currency liabilities of the corporate sector that is exposed to balance sheet effects of depreciation and large refinancing risks
· Large financing needs of the government given the need to roll over short term debt
· Limited room for a fiscal stimulus as medium-term fiscal discipline needs to be maintained
· Risk of a serious recession in 2009 (-1% to -2% growth in 2009)
· Large and growing unemployment rate
· Rise in non-performing loans of the banking system (mortgages, credit cards, auto loans, corporate loans) as the recession leads to a rise in delinquencies for households and corporations
· Sharp fall in a stock market where non-residents hold 70% of the market capitalization
· Risk of a faster and more disorderly fall of the Turkish lira
· Political instability given the conflict between the traditional secular state and the islamist government
· Risk of populist fiscal policies before the spring provincial elections
· Stalled process of the negotiations for Turkish membership in the EU
I discussed such strengths and weaknesses of Turkey in a separate TV interview while in Turkey:
“ my view on Turkey is that certainly compared to 2001 when you had a very severe economic financial banking crisis, the overall market and financial outlook is much stronger. You have had the primary surpluses and the fiscal condition of the Government is much better. Independent central bank with trying to achieve inflation stability. You have cleaned up your financial system. The banks have much more capital and liquidity. They have less of those mismatches that caused trouble. The supervision and regulation has become much stronger. So the overall framework is there and all these reforms has led to growth, and growth of exports and competitiveness and so on. So the framework from which you started is stronger one. Of course through trade and financial links Turkey is related to global economy when the demand for Turkish exports falls sharply from Europe and other parts of the world, then that's a negative for Turkey when there is that amount of capital available, and cost a bit higher then Turkey has to finance its external debt. It has to roll over the debt of the Government, the debt of corporates. That becomes more difficult. So this current account deficit, and the debts of the private sector, corporate or the Government is always an issue that you have to address. The currency had become, in the past, too strong, is now starting to weaken. That's good news for exports, but in a global economy that is weak then export growth is going to be weak. The value in local currency of foreign debts in foreign currency of the corporates is going to rise. That's a negative. So it's a difficult time for Turkey, I can say…
…there are definitely constraint policy. In my view, an IMF programme will be actually good for two reasons. One, you may have a liquid in foreign currency twenty, twenty-five billion dollars that given the need to finance fiscal deficit and current account deficit, and roll over some of the debt that comes to maturity of corporates, financial institutions, private sector, public, then that gives you more confidence to be able to do it if market conditions remain tight. And also, you know, Turkey is one of the countries that had a successful experience with IMF after its crisis those IMF programmes led to economic reform, that then led to recovery. So... so on fiscal policy of course there is a trade off between the fact that you want to maintain fiscal discipline for the medium term. That's necessary. And on the other side, in the short run, some degree of fiscal easing appropriate, and you know has to be in the right places, and so on, is needed as well to try to stimulate the economy. Monetary policy is going to become easier as inflation falls and the Central Bank cut rates. So there are many parameters on which the country can work, there are constraints, of course to what it can do, but there is room for kind of having the policies that are going to go in the right direction, restore growth and deal with this financial pressure that we see this year...
…I do believe, because many of the booms and bust in Turkey in the past were due to, you know, the policy cycles of, you know, periods of high inflation, and then you have to tighten, and then you have a recession, or you have excesses, and then you have crisis. So I think those things happen. I think that the 2001 crisis was a moment of really improving many things for the better. This time around you have difficulties, but most of them are not of your making. You know. You are also the accidental kind of victim of the fact that you have this financial tsunami that's hit from the U.S. the rest of the global economy, and you had done many of the right policies. Of course every country has some vulnerability. In the case of Turkey, still currently on deficits and other imbalances. So, you know, I think this year is going to be difficult year for everybody including Turkey, but I think the lesson is to continue to maintain sound macro, financial and structural reforms because, you know, it will be a difficult year, but then there will be a return to growth. So continuing their path of doing market oriented reforms is necessary, and is going to be the way of recovering and avoiding a more severe downturn
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