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But that limited view is not particularly helpful for the longer term investorHistory of Bear Markets To be ignorant of what occurred before you were born is to remain forever a child. For what is the worth of human life, unless it is woven into the life of our ancestors by the records of history? Cicero, 46 BC THE USE AND ABUSE OF HISTORY History never repeats exactly. When we look to history for indicators of what the future might bring, we need to take a little of this model and a little of that in order to create a new composite model that is unlike anything that has happened before. This lesson has been forgotten after 20 years of an almost unbroken bull market. The possibility that we could get a protracted multi-year global bear market and recession is outside the comprehension of most investors. Most floor traders and fund managers today began their careers after 1980, so have no personal experience of the massive inflationary bear market of the 1970s. And when it began in 1966, many of them were not yet born. TECHNOLOGY FOSTERS LAZY THINKING Since the introduction of stock market software, it has become increasingly fashionable to compare todays stock market patterns with past models, without taking into consideration that what created those particular patterns were not just market related but caused by cultural and political factors as well. Technology has made our lives infinitely more comfortable. But it is a doubleedged sword. The more we rely on technology, the less we think for ourselves. And making informed judgments on the future of securities markets, based on an inner sense that comes from working with market data over many years, has become a lost art. Yet, there are so many factors that affect market behavior that cannot be reduced to a software package or a computer-generated predictive system. In this chapter, we list all bear markets for the last 100 years. But it is up to you, dear reader, to apply the models of history to current and future conditions, using not just market history, but the history of social, political, and economic events for the 20th century. An in-depth discussion of how these non-market historical events interacted with market action is outside the scope of this book. I therefore suggest you obtain a good year-by-year social history book of the last 100 years, to use in conjunction with this list of past bear markets. Youll find it fun. TAKING A VIEW In Europe, where capital preservation is of a higher priority than a quick profit, they are in the habit of taking a view. While they may trade the intermediate and short-term swings of the market, they do it within the context of a multi-year concept of where the world in general economic terms is heading. This creates a difference between the two continents in how bear markets are defined. In America, all bear markets tend to be given equal ranking, with no consideration to the bigger picture. But that limited view is not particularly helpful for the longer term investor, particularly in todays investment climate. I will elaborate on how taking a view applies to the next few years in Chapter 19. But, in this chapter on bear market history, let us concentrate only on the past. In the last 70 years, there have been two major occasions when taking a view enabled you to see a different, more accurate picture of events, than simply treating every uptrend in the market as a bull market, and every down-leg as a bear. These periods are 1929 to 1942, and from 1966 to 1982. Both periods were times when there were major economic and monetary problems that took well over a decade to resolve. Both periods were mirror images of what we have experienced between 1982 and 2000. On an economic and financial level, those 18 years have been a time of considerable growth. This gave rise to an almost continuous bull market. The mini-bear markets of 1987 and 1990 were almost exclusively Wall Street phenomena, in that little or no damage was done to the economic and financial health of the companies, which stocks represent. The major uptrend remained intact. But the long-term investor, who did not sell out before August 1987, found himself with major losses just 2 months later. And, by October, there was a lot of panic selling. But the investor who took a view would have known that October 1987 was not the time to sell. However, if that same long-term investor had looked at the underlying financial and economic structure in the late 1960s, he would have seen that not only was there a bubble mentality in electronics stocks, but that there were profound fiscal problems which were eating away at the economic health of American companies. This ultimately led to double-digit inflation. A new major bull market did not begin until the inflation was squeezed out of the economy. Between 1929 and 1932, the economy sustained tremendous economic damage. Even though the Dow rose 268% over the next 5 years, the damage caused to the economy and the dollar was not resolved until 1942. Thereafter, a sustained bull market began, which did not end until 1966. My point is that the simplistic conventional definitions of bear markets, that simply measure the extent of the drop in the various Averages in some sort of ratio to the time it takes for the drop to occur, are not very helpful to an investor deciding whether to unload his stocks at a loss, or hold on in hopes they will go back to their old highs. This doesnt mean that one should have gotten out of stocks in early 1929 or 1966 and taken a holiday from the stock market for the next decade or so, although some people did. Instead, it means that when your taking a view indicators tell you that there are major economic and monetary problems that are likely to take a year or more to be resolved, you no longer can buy and hold, but should become a more watchful and flexible investor, playing the major upmoves, but doing so with one hand on the exit all the way up. I belabor this point because as of this writing, in early 2002, some analysts are predicting the beginning of a new bull market. I do not necessarily disagree with them. The Dow Jones Industrial Average or S&P Average could retrace much of their losses since 2000. If they do, they will do so with little regard for the global economic and monetary problems that began long before the September 11 attack, and will be there for some time to come. The cry of those proclaiming a new bull market is that the market generally leads the economy by 3-6 months. So, if we are in a new bull market, that must mean economic problems will be solved in 2002. That displays a faulty knowledge of history. The major bull market in the 1930s, and the two major bull markets during the 1970s, did not herald an end to the underlying monetary problems. Quite the reverse. In all cases, it was the lack of solution to the underlying health of the economy that pulled the markets back down. Why should we take a view and not treat all bear markets as equal? An example of this wrong thinking is the comparison of 1987 to the crash phase of 1929. Many people believe the Federal Reserve single-handedly prevented 1987 from becoming another 1929. Ergo, we now know enough to prevent another major bear market and depression of the 1930s magnitude. But if Fed intervention, which worked so well in 1987, is the way to prevent all future bear markets, why is it that since 2000, after more aggressive cutting of the discount rate by the Fed than at any time in history, there has been no 1987 style turnaround? 1987 AND 1929 COMPARED After a 6-year bull market, beginning in 1923, the DJIA more than quadrupled, reaching an all-time high on September 3, 1929. The DJIA lost 40% during the next 55 days. In a selling climax on October 28 and 29, 1929, the DJIA lost 20% in just 2 days. After sustained growth which began in 1984, the DJIA had almost tripled its low point of 3 years earlier. The Dow reached its peak of 2,722.42 on August 25, 1987. The 1987 crash phase, as with 1929, began 55 days after the late summer high. From peak to trough, the 1987market lost36.1% of its value,compared to 39.6% on the first leg in 1929. For somebody who did not take a view but looked only at the numbers, it appeared that 1929 and 1987 were similar bear markets. Those investors who, in 1987, believed they were seeing a rerun of 1929 came to two different and equally wrong conclusions. One group believed that 1987 was the beginning of a 1930s-style bear market, so missed out on much of the bull market which followed. The other group saw the Federal Reserve as a kind of latter-day Merlin, capable of creating permanent prosperity out of a potential 1929 situation. This latter group are still wondering why the recent, most aggressive rate cutting in history didnt pull the same rabbit out of the hat that it did in 1987. As Mark Twain said: There are lies, damn lies, and statistics. The ability of computers to crunch numbers faster and better than ever before is a wonderful advance. But it has its drawbacks. The good side is that computers can process numbers and find connections that previously was impossible. The bad side is that ever more reliance on computers causes people to think ever less. And investing requires thinking. It is not a lazy mans hobby. THE BEARS RECORD BOOK The first step to creating that composite model to see what the future may look like is to glance over past bear markets. Youll find this of great help as reference material in the years to come (and especially for all the bear markets ahead). No single past model exactly applies to today. My list begins in 1900, because this was the first bear market after Dow created the DJIA in 1897. Panics and crashes from earlier times also have things they can teach us, but prior to 1897 market statistics are vague, so anything earlier can only be referred to in a general sense: 1900 DJIA declined 31.8%. Duration of bear market: 12 months. Crash came in December 1899. Bear market low in June 1900. 1903DJIA declined37.7%. Duration:10months. Crash occurred in November 1902. Bear market low in September 1903. 1907 DJIA declined 45.0%. Duration: 10 months. Had two crash phases, the first in February (DJIA fell 21.8% in this first phase); rallied in March and April. second crash was July to November, a 4-month fall known historically as the Panic of 1907. A bull market started at once after the second crash. Stocks lost almost 50% (many much more) from the bull peak. A further fall was prohibited by the fact that business did not fall much further after the October economic collapse. Business coasted in a top area for 8 months after the start of the first market crash, then, suddenly and without an alarm, plunged down almost vertically in the midst of the second market crash. Business indicators hit bottom 3 months later, stayed there for 4 months, then began a healthy recovery: 1909DJIA declined 26.2%. Started in November 1909, with the crash phasein February 1910. The bear market low came in July 1910. Duration: 8months. 1912 DJIA declined 23.5%. Duration of bear market: 26 months. Crash came in June 1913, but bear had started in November 1912. Bear low came in December 1914. Since the stock market was closed for 4 months in 1914 by the war, a true picture of the decline here is impossible. One source says it was 36.3%. But Ill take the more conservative published DJIA figures as my base. DJIA declined 40.1%. Duration of bear market: 13 months. Crash phase came in December 1916. Hit bear market low in December 1917. 1919 DJIA declined 46.6%. Duration: 21 months. Three crash phases. Initial crash November 1919 to February 1920 (DJIA fell 25% in this first phase). Second crash in late 1920. Final crash in summer of 1921. Hit low in June. Business topped out slowly during the first market crash, then coasted rather indecisively just below its top area for 6 months after the crash. Then it plunged sharply, right after Labor Day, 1920. A depression lasting 1 year followed. Business then recovered simultaneously with the stock market. The year 1921 was notable for a downswing that lasted 6 months nonstop, the second longest downswing in bear market history. 1923DJIA declined 18.6%. Duration of this baby bear market: 7 months.1926DJIA declined 16.6%. Duration of baby bear market: 2 months.1929DJIA declined 90.0%. Duration 34 months. Six successive market crashes comprised this famed bear: (1) September to November 1929 (DJIA fell 40% in this first phase). (2) April to June 1930. (3) September to December 1930. (4) March to May 1931. (5) July to January 1932. (6) March to July 1932. A new bull market then started immediately, as did a business recovery. had topped out mildly, a month before the first crash; a gradual mild decline continued to April 1930, then fell sharply into a depression simultaneously with the end of the 1930 stock market rally. The business decline halted in December 1930, stayed level for 6 months, then plunged again in steep economic decline that didnt lose its downward momentum for a full year, until July 1932. Business improved intermittently thereafter but still remained at depression levels through most of the 1930s except for a short recovery in 1936-37. Rarely included among bear markets. But a fall of 24.1% in the DJIA gives it a deserved berth here. Duration: 9 months. Then the market took seven more months to get back up to where 1934 began. 1937 DJIA declined 51.8%. Duration: 56 months. Five crash phases: (1) August to November (DJIA fell 40% in this first phase). (2) February to March 1938. (3) January to April 1939. (4) May 1940. (5) October 1941 to April 1942. Business peaked out and fell violently, simultaneously with stocks. Economic indicators bottomed out 9 months later (May 1938). The recovery began mildly at first, but was later boosted by the World War II production boom which eventually lifted the country out of the Great Depression of the 1930s. The period 1941-42 contained the longest bear market nonstop downswing (72 months) in history. Certain analysts call this two separate bear markets, one from September 1937 to March 1938, and the second from May 1940 to April 1942. If you are simply looking at market action this view may be correct. But if you take a wider view within the context of the depressed mood of the times, then it can be viewed as all part of a single bear market. 1946 DJIA declined 24.6%. Duration: 37 months. There was only one crash phase (August-September 1946), and the bottom was hit within 4 months. But the market moved sideways for almost three years and tested the 1946 low area three times. The final time was in 1949, after which the market rose almost without interruption for the next 12 years (160 to 741 in 1961). 1953This was a very small bear market, but, as it was caused by war (Korea)uncertainty, I include it here. DJIA declined13.9% (295 to 254).Duration of this quasi-bear market: 9 months.1957DJIA plummeted 106 points (522 to 416) for a 20.3% fall. Duration: 6months. 1960 Opinions differ on whether this was a real bear market. But Dow Theory signals were given, so it is included here. DJIA declined 18.0%. Points lost: 124. Duration: 10 months. 1962 DJIA declined 29% in 6 months. Extent of 1962 damage: the first crash phase of 1929 lost 40 billion dollars. The 1962 crash lost over 100 billion dollars. Even if we adjust those values in terms of 1929 purchasing power, the 1962 crash still lost one and a quarter times as much as in 1929. Market plunged from 1001 to 735 in just over 8 months. This was the end of the postwar super-bull market. At this point, the whole atmosphere of the stock market changed. A new factor entered the investors reasoning. Not only must he now assess the direction of the economy, he must also consider government monetary intervention, which might make him think he was making a profit, when in fact, in real value terms, he was not. We will discuss this at greater length in Chapter 19. 1968 This was a long, drawn-out bear market. The DJIA declined from a high in December 1968 of 994, down to a low of 627 in May 1970. This was the first of the new-era bear markets, caused not so much by a simple downturn in business but by currency woes. 1973 This one was scary! From a high of 1067 in January 1973, the market slid relentlessly down to its final low of 570 in December 1974. Its catalyst was the oil crisis. For the first time in American stock market history, a foreign power, or group of powers, were able to precipitate an economic slowdown. We had entered a new level of globalization after which the world would never be the same. 1977 DJIA fell fairly gradually, though gathering some momentum as it went from just over 1000 in January 1977 to a low of 736 in March 1978. Nothing dramatic caused it; rather more of the same of the past decade: increasing oil prices with dollar stability problems steadily worsening. 1981 This bear snuck up on people. DJIA made a rare quadruple top that convinced most investors it was building strength to break through. DJIA fell from 1025 in April 1981 to a low of 770 in August 1982, or 255 points. A mere 17-month-long bear, it led to a recession which was more severe than the stock market fall would indicate. 1984Though this is not even considered a bear market by most, it scared alot of investors because it broke below a giant support area andappeared to be heading back to the1000level, whence the bullmarket of late 1982 and all of 1983 had come. It fell 16%, from 1295to 1080 in 7 months. This was a heart-stopper for the very reason that there was no apparent economic reason for it to occur. There were two catastrophic days of multi-hundred point drops, with one of those days being the largest one-day point drop in history. It came about because of computer programming (explained earlier), computer insurance schemes, and the globalization of markets. It was historys first simultaneous global bear market where all major world markets were hit badly at the same time. Australia was among the hardest hit, Japan among the least, but all had considerable damage. DJIA fell from 2747 to 1616 (i.e., 36.1%), in less than 2 months. It took nearly 2 years to surpass its prior high. 1990 This was the direct result of Iraq invading Kuwait, and was halted when the US launched Desert Storm. DJIA declined 17%. Duration: 4 months. This bear market, along with that of 1987 are the shortest bear markets in history. 2000 By October 2001, the Nasdaq was down a whopping 72% though the DJIA was only down around 25%. But most worrying, well before the September 11, 2001 terrorist attack, was that the underlying economic health of the US and most world economies showed increasing signs of weakness. It is already clear that this bear market has damaged the broader economic health of all major economies, more than any other bear market in the last 60 years. But more of this later in our predictions chapter. BEAR MARKET FREQUENCY RATIO So, there you have the bear markets of the 20th century, and the first one of the 21st century. There has been a bear market every 4 years on average. The longest time span between bear markets has been the most recent bull market, which was 10 years if you regard 1990 as a major bear market; 20 years if you take a view. This is the powerful message, then, of this chapter: that even if you weight all bear markets as equal, and dont think in terms of multi-decade papa bear markets within which mama and baby bull markets are possible, bear markets are frequent enough to make it impossible to ignore them, even in major boom times, or to avoid their losses. The decade of the 1990s was unique and, like the bear markets of 1987 and 1990, occurred because of a unique set of circumstances that are unlikely to repeat, let alone be considered a new paradigm for bull markets in the future at least not in our lifetimes. Thus, the investor must try to understand bear markets better. Otherwise, the profits from the previous bull market are usually wiped out. AVERAGE PERCENTAGE OF VALUE LOSSES You have also seen that the percentage of decline in bear markets ranges from as little as 13.9% up to 90%. The total of all these percentage losses is phenomenal. The losses represented by all these declines are staggering, but when you realize that the blue-chip averages never fall as far as the great mass of small cap stocks, the damage to your wealth during a bear market can be more than most people can deal with. The averages mask a greater percentage fall by the majority of stocks not in the averages. Add to that the economic and fiscal damage that often accompanies a bear market. Say you lose your job, and that small stock portfolio was your safety net. Or you needed that extra money for the kids college fund, or an unexpected illness. You can be sure that the kids education or sickness in the family wont only occur when your stocks have recovered any losses they might have suffered in the prior bear market. Unfortunately, during the 1990s, people came to regard investing in stocks as like putting their money in the bank, except that many were making 30% per year instead of bank interest of 5%. LENGTH OF BEAR MARKETS Bear markets have been as short as 2 months and as long as 5 years, the average being about 18 months. This current bear is already the longest in 60 years, which of itself suggests that although we may see what many analysts call a new bull market, it will more likely resemble those baby bulls of the 1930s and 1970s than the major bull market of the 1990s. Also, it should be noted that, in the 20th century, markets were in a bear phase for 341 months (i.e., 28 years of bear markets), and, in the last 90 years, we have been in bear markets 35% of the time. If that statistic doesnt change your belief in a buy and hold investment strategy, nothing will. Clearly, this makes the stock market a dangerous placewith a pitfall hidden under every third stepping stone. Not only does it mean the permanently bullish investor only has two chances in three at best, but when you consider that the depressed psychological climate at bear market bottoms prevents the majority from investing at the best time, it means that, by the time the majority of investors recognize a bull market is present, it is half-gone. But by showing you how to face bear markets with confidence, and make money in them, I hope that, by the end of this book, you will be among the first people to invest in the next great bull market. TRUE RISKS ARE STAGGERING The situation is made worse by the fact that the average investor (90% of investors) cant be expected to spot the exact top of bull markets and sell out in time. This means he loses much of the prior rise before he does sell. A professional man, a physician, who throughout the late 1990s prided himself on his ability to trade online, admitted to me a few months ago that: I havent sold anything because what would I do with the money? Then, a month after the September 11 attack, he remarked that it was only on October 1 (i.e., 3 weeks after the attack) that he had the courage to switch on his computer to check the prices of his stocks! His reactions, which I am sure were echoed by millions of investors across America, surely explode the myth that you can just invest and sit and wait. Everybody needs a plan, one that includes strategies for selling as well as buyingand (once understood) for selling short when that seems to be the prudent course of action. Without a plan of action, when the unexpected occurs, when markets suddenly fall, or terrorist attacks strike, that is not the time to think up an investment strategy. It is a time to act on realistic strategies for both bull and bear markets that you had already decided upon, when you were feeling less stressed. PERIOD OF READJUSTMENT For those who still believe that if they hold on they will do better than if they sell at a loss, let me reveal another statistic. After each of the 21 bear markets prior to 1987, prices did not immediately zoom back to new high ground. This V bottom, that analysts always tell you they are expecting shortly, has absolutely no history in prior bear markets that have gone on over 18 months, as this one has. Most of those 21 bear markets took many months or even years to get back to where they were before the fall. After the 1929 bear, it took 26 years to recover. If that is too extreme or too much like ancient history to you, it took 14 years after the 1937 crash, and the 1966 peak of 995.15 was not decisively breached on the upside until 1982 (i.e., 16 years later). And, along the way, there were some pretty wild swings to the downside including the 1974 low when the DJIA lost nearly 50% of its value, and in ever more inflated (depreciating) dollars. So to buy and hold, you not only need lots of patience, lots of spare cash (so you wont need to draw on your investments to pay bills), but you also need nerves of steel to sit through the decline. LEARNING FROM THE PAST I saw a new heaven and a new earth . . . and the former things were unremembered. This seems to be true of every age. In 1929, they had had seven prior bear markets, just since 1900, on which to build their knowledge. But it was to no avail. People, by nature, almost defy learning from the past. They contend that having had depressions, man acts to prevent their recurrence. But the evidence doesnt support this. Militaries usually focus on better ways to fight the last war, thats why when terrorists used a passenger plane as a megaton bomb, not only was the military totally unprepared to deal with such an attack, but Intelligence (which is supposed to find out about these things before they happen) had no idea such an attack was imminent. Both military and Intelligence were focused on possible terrorist use of smart bombs a la the Gulf War, or nuclear devices. So too with many economists and market analysts, who compile the data from past bear markets, and then search current market conditions for an exact match with past models. Any future bear market will be sufficiently unique and there will be sufficient proof that this bear does not fit any prior model, to enable people to deny that it is happening all the way into bankruptcy. CONCLUSION If a conclusion is possible, it is probably that the only way to avoid odds that are little different from red and black in roulette, is to play both sides of the wheel (i.e., be willing to hold stocks long or short (or both) as circumstances warrant). You should have contingency plans in place if markets dont act as you expected, and use what economists call unarticulated knowledge, but which the rest of us call intuition: that inner judgment that takes into account social, political, and cultural conditions, often without bringing it to your conscious attention except in the form of an uneasy feeling. Be flexible and trust your instincts. |
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