A cub Market?

Through the first three quarters of 2004, the equity market indexes saw little in the way of gains and may have appeared to be going "sideways" as some have put it. For example, the Dow Jones Industrial Average is down 2.09 percent since January 1 and the Standard & Poor’s 500 Index is up only 1.53%. Of course it is not unusual to see less volatility in presidential election years. Data contained in The Stock Trader’s Almanac 2004 indicates that the probability of a negative return in the S&P 500 during election years from 1952 to 2000 is only 7.7% versus a 25.6% probability in non-election years. This adds to the neutral or sideways perception. Nonetheless, we are seeing more headlines that imply that the bull market run that followed the tech bubble of 2000-02 has run its course and another bear market could be in the offing. Or is it?

With this in mind, we researched market patterns since 1926 and discovered a new market species that is quite interesting and reassuring. We call this new creature the "cub market." Before bears grow up they are cubs. We define a cub as a market downturn of between 5 and 20%. (Once the decline reaches more than 20% it grows into a bear market.)

With this new animal defined, we hunted for as many as we could find by analyzing the S&P 500 Index from 1926 through 2003. We discovered 89 cub and/or bear markets during this 78-year time frame. Thirteen of the cubs grew up to become bear markets. In 23 of the 78 years, there was no cub or bear present. This means that in the remaining 55 years, there were 76 cubs – about 1.4 per year. The average duration of the cub markets was 2.3 months.

So what does this mean? First of all, market declines of 5 to 20% are very common and should therefore be expected. In fact, we should expect one or more every three out of four years. This is normal market activity. Additionally, knowing that even with the frequency we have outlined here, bull markets still occur 80% of the time, with bear markets in place the other 20% only. (See page 33 in our book, There for the Taking.) Therefore, market hiccups are not only normal, but even desired. Yes, desired. Why? Let’s take a look.

Further analysis of our data revealed that in the 30 days following a cub or bear market, the S&P 500 gained an average of 4.65%. On eight of the 89 occasions, double-digit increases occurred in just one month.

It is clear that if investors can understand the normal fluctuations of securities markets, they will be less likely to make the BIG MISTAKE – that is, selling out to avoid a loss. While it may sound trite, the only way to lose money in the market – absent proper super-diversification - is to sell out. Knowing how quickly the markets have historically bounced back after these common adjustments gives investors the information they need to stay the course and take advantage of the tremendous growth that can be attained with the proper amount of patience.

Here is the dangerous situation you must avoid: If you have just been ‘burned’ by the markets and decide to get out so you can sleep at night, what are the chances that you will get right back in given your emotional state? Will you get back in within 30 days … 90 days … a year? It is likely you will wait at least some period of time beyond 30 days to regain your confidence. However, if you have the proper understanding of the market cycles – whether cub, bear, or bull – you will be in a position to take advantage of market forces by staying the course and get plenty of restful slumber. Heck, you might even consider hibernating.

 

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