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Ignore the “Experts”: We’re in a Bear Market

Ignore the “Experts”: We’re in a Bear Market

Article Highlights:

  • Every analyst agrees a bear market is defined as a 20% decline from the Dow’s high.
  • Books from the 1920s give a more detailed definition of a bear market.
  • Analysts are still looking for a bear market … but it already happened; we’re in a bear market right now.

I was watching CNBC the other day. Sometimes I forget they can’t hear me, and I start arguing with the so-called expert.

I argue with CNBC often. In my living room, I sound just like a sports fan arguing with ESPN.

Many CNBC guests seem to get all their information from other CNBC guests. I guess that’s just how it is now that we have the internet.

When I was young, we had books. I know we still have books. But I think many experts spend more time reading online commentary than studying books written decades ago.

That’s a shame, because those old books contain useful information.

Defining a Bear Market by Using Old Books

My latest argument is about when the last bear market ended. On CNBC, it seems every analyst agrees the current bull market started in March 2009.

Every analyst agrees a bear market is defined as a 20% decline from a high, based on closing prices for the Dow Jones Industrial Average.

The Dow only fell 19.2% in 2011. It only dropped 19.4% in 2018.

On CNBC, a 19.99% decline means it’s not a bear market.

In old books, the definition of a bear market is more detailed. Some describe precise levels. Others note market action meeting the goal of a bear market.

To see how that latter idea works, consider books from the 1920s describing how Charles Dow looked at the market.

Building Arguments From Simple Ideas

Dow developed the Dow Jones Industrial Average and the Dow Jones Transportation Average. He started that project in the 1880s. He thought the averages would help him understand the economy.

Decades later, economists proved Dow right. In the long run, there’s a link between the economy and stock prices.

Another example of Dow’s work is his definition of a bear market.

He built arguments from simple ideas. Dow noted that prices move up and down because traders get carried away. So, prices always go too far in one direction.

A market rally, Dow noted, leaves stocks overvalued. A decline pushes prices down to where they should be based on economic fundamentals.

Bear markets, to Dow, corrected the excesses of bull markets. He saw two ways for corrections to occur.

A sharp decline of 20% or more corrects excesses of bull markets. Sideways price action for six months or more also corrects excesses.

Sharp declines align stock prices with fundamentals by adjusting prices. Sideways action, what Dow called a line, aligns the two by giving fundamentals time to move to where the prices are.

Where We Are Now

Over the past 18 months, stock prices moved sideways. Even though prices ended up where they started, there was excitement getting to the end.

This excitement is where CNBC’s analysts look for a bear market. They didn’t find one. Stepping back, we see a Dow line replaced the decline analysts looked for.

Stock Prices Moved Sideways

Every analyst agrees a bear market is defined as a 20% decline from a high. But in old books, the definition of a bear market is more detailed.

Remember, Dow said the purpose of a bear market was to align prices with fundamentals.

Fundamentals improved in the past 18 months. The next chart shows the price-to-earnings (P/E) ratio.

The P/E Ratio Shows Fundamentals Are Improving

Every analyst agrees a bear market is defined as a 20% decline from a high. But in old books, the definition of a bear market is more detailed.

(Source: Standard & Poor’s)

Today, the P/E ratio is 23% lower than it was in January 2018. That’s the kind of contraction in fundamentals we see in a bear market.

This confirms Dow was right. Lines can replace bear markets. At least when we define a bear market as a time when fundamentals and price realign.

Fundamentals are better than they were 18 months ago. And stocks will move higher from here.

In other words, the bear market happened while CNBC’s analysts were talking about how we haven’t had a bear market. We’re in a bear market and they’re still looking.

Regards,

Michael Carr, CMT, CFTe

Editor, Peak Velocity Trader

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