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Anatomy of a Bear Market:  When Can We Recover?

Anatomy of a Bear Market: When Can We Recover?

March 24, 2020

This morning, prior to the opening bell on the NYSE, the Federal Reserve, in what seemed to be a desperate attempt to stop the bleeding in the markets, announced an asset purchase program where the government will be buying different types of corporate, municipal, and other governmental debt vehicles to provide “liquidity” and “stability” to the bond market which, in turn, Jay Powell and company are hopeful they can artfully stop the stock market train wreck on Wall Street. 

So far, during one of the most momentous times in our history, the Federal Reserve and the US Treasury have both thrown the “kitchen sink” at COVID-19 to shore up financial hits that are being taken by virtually every American and almost all businesses in our country on the whole.  But what will really happen to stocks?  Can the government fix the markets? 

I think the answer can be found by breaking down the anatomy of a typical bear market.

Generally speaking, a bear market has several phases…

Phase one is realization.  In my opinion, it’s impossible to recognize the beginning stages of a bear market.  I mean, if you think about it, bear markets have to start somewhere, right?  And usually, they are born as every day, normal, garden variety market corrections after an index falls anywhere from 5%-10% from a recent peak.  Next, investors debate each other about where the markets are:  some are screaming “buying opportunity!!” while others are getting more and more nervous that we’re “on the brink”. 

As with most pullbacks in the markets, relief typically follows, markets rise again, and the “bulls” who were screaming “buying opportunity” begin chanting “told you so!”…Over the last year or so, we saw this type action in the markets where almost every dip was able to be bought and the run up in stocks seemed to be endless.  Meanwhile, we witnessed many investors, investment servicers, and financial consultants alike boasting about their “returns” and how they “never lost money during their 10-year track record” as the worn out, tired, old bull began his exit stage left while a refreshed, hungry bear is back from hibernation sniffing out fresh blood.  Indeed, the market did nothing but go up over the last ten years and, as I have mentioned in many messages before, Capstone’s advisors were reducing portfolio investment risk at opportune times, while too many investors and their consultants were overrun with complacency and might just now be realizing what’s going on around them.

During its transition from bull to bear, the market has a tendency to “test” the extremes and when stocks finally lose their footing and are unable to hold their gains and break new highs, they begin to collapse, realization sets in and we go on to phase two…

Phase two is fear.  In this phase, investors begin to realize that “buying the dip” was a mistake and as the losses in their portfolios are being exacerbated by this “legendary error”, distress sets in as they begin to question their allegiance to a time-tested strategy which has now failed them miserably.  This is where fear takes over, emotions run high, tolerance for risk evaporates, logic is out the window, and, to anxiety-ridden investors, all of sudden, stocks become losing lottery tickets that are deadly to the touch.  Sound a bit familiar?   We are surely in the fear phase right now…Investors are freaked out, the markets are in free fall, our economy is dust right now, and the Dow Jones Industrial Average has lost 37% of its value during the quickest decline it has seen since the Great Depression.  Yep, we’re there…The fear phase is in full force.

So, when does the fear abate?  Fear will give way to extreme panic when the markets see all of the conditions that must be met in order to bottom out (see my last post about that here: Equity Roller Coaster Ride: Can We Find a Bottom?).  As soon as panic has faded, we get to phase three:  equilibrium.  During this phase of the bear, some common sense returns to the markets - Investors begin to understand the reality as to why stocks fell so hard in the first place, why the former bull market highs didn’t make any sense, and, regardless of the underlying reasons, investors realize there are real problems in the markets and in the economy that caused all of this – whether it be an epidemic or a credit debt crisis, it doesn’t matter.  The equilibrium phase is not a recovery period, but it is a time where stocks fight to find direction and volatility continues to run very high.  During this phase rational thought and logic slowly creep back into the market as stock valuations begin to find a foothold before the bear finally retreats into hibernation…Recovery comes next.

The recovery phase is much like the realization phase in that nobody really knows what’s going on.  At this point in the process, it’s very likely that the bottom in stocks is already in – even though the headlines are ghastlier than ever, the wounded continue to grow in numbers, and the “end” feels more imminent than ever before.  During this phase, however, investors will begin to see “green shoots”, stocks start to ignore negative news, and fundamentals take back the spotlight…This is where markets resume their inevitable upward, long-term trends, where new bull markets are born, and stocks begin to win again.  

Overall, the phases of a bear market can take many months to endure, but being prepared to get through a bear is what investors need to focus on.  In the longer term, controlling risk and properly managing asset allocation will prove to be successful and provide better retirement outcomes.  We just need to get through it – we don’t need to outsmart it.   

After 22+ years as a financial planner and investment advisor, I thought that I had seen it all.  But here we are in unchartered territory once again.  Americans are fighting an invisible enemy, we are now in a self-induced economic coma, and medical uncertainty is resonating as our healthcare system potentially hangs in the balance.  At Capstone, we are a registered investment advisory firm, and, as such, we spend most of our time focusing on financial planning, investment modeling, and controlling risk – but, tonight, I would like to end this post by recognizing and thanking all of the people that are on the front line fighting COVID-19…Those people that don’t have the luxury of working from home or skipping their shift at work tomorrow.  We are extremely grateful and indebted to all of the heroes who forgo their own safety to save and protect the lives of those in need.

From all of us at Capstone Wealth Management Group, we thank you.   

(The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.)