what bear markets look like

Bear markets have two key characteristics:

1.  psychological.  In a bear market, investors ignore good news and obsess over bad.  Negative stuff is all that gets a reaction–and it’s always to sell.  The opposite is true in a bull market.  Then, people focus on good news and use it to justify bidding stocks up.  Maybe they know bad stuff, but that’s just  intellectual awareness, and they don’t let it get in the way of the market party.

That’s certainly the current stock market mindset.

2.  economic.  Garden variety bear markets stem from government action to slow down an overheating economy.  They last about a year.  Longer, deeper ones have come from structural failures.  The sharp oil price increases of the 1970s are the standard example.  The financial meltdown of 2007-2008 is the most recent one.

Neither seems to me to be the case today.

the current situation

Emotionally, the bears are in control in world financial markets.  On Wall Street, we’ve moved down, pretty much in one-way fashion, from 1356 on the S&P 500 in early July to 1074 intraday yesterday.

Economically, however, the world continues to be in recovery. Anemic, yes, but recovery nonetheless.  In fact, recent economic indicators suggest the world is in a little better shape than the consensus has been expecting.

yesterday’s trading started badly…

Yesterday’s fall was typical bear market performance.  Stocks dropped from the open, despite positive domestic economic news and a report from the Macau government that gambling revenue was up 39% year on year in September.  The Macau increase came even though a typhoon toward the end of the month virtually shut Macau down for a day or two. The report shows, I think, that the predictions of a sharp slowdown in spending by affluent Chinese are at best premature.  (Plausible or not–I’m in the “not” camp, the predictions are all that Wall Street has chosen to hear.)

The casino stocks, and names like TIF that have important Chinese exposure, rallied early on the Macau news but had lost all their gains and were headed for negative territory by 3pm.

…3pm news drew a sharply positive reaction…

Around that time, news from Europe began to circulate that the EU had finally decided to act to shore up the financial strength of its major commercial banks.  That would put an end to worries that bankruptcy of EU member Greece would cause the banks–major lenders to Athens–to collapse.  It would also put to rest fear of a second devastating period of paralysis of world economic activity, like the one that followed the Lehman bankruptcy in late 2008.

Wall Street rallied almost 5% in a little more than half an hour.

…showing, I think, investors’ true concern

If yesterday is a good guide, the main reason for continued selling is anticipation of a repeat of the dark days of September 2008-March 2009, not a reaction to an economic action–which is historically what bear markets have been all about.

Investors aren’t so concerned about the possibility that long-term unemployment being high in the US or about short-term-growth slowing in China from 10% real to 5% real.  It’s all about EU policy.

if so, what good is knowing this?

It makes some sense of the peculiar situation we’re in, that the economic facts and the market psychology don’t match up.

It suggests to me that thinking carefully about the worst case that’s likely to come out of Europe is important to do.

And it seems to me that the situation in Greece is quickly coming to a head and that EU governments will have to act before the end of the year.

So we may currently be in the situation of a bear market in time from now on, rather than one of market levels–if the worst that can come from the EU is almost fully discounted.  And a positive turn in sentiment would presumably come from policy action, not from the lengthy process of economies reaching and passing an economic low point.

This doesn’t necessarily mean that markets will go rocketing up if a reasonable resolution of the Greece crisis is reached.  But it does seem to me to imply that market attention would return to the “normal” business of assessing company fundamentals–and that stock picking would again be a fruitful way to pass the day.