Tuesday, July 8, 2008

The Bear Market Labeling Myth

commentary from this week’s “Sectors and Styles Strategy Report”*:

“So let it be written. So let it be done.”
The Ten Commandments

Labeling, such as equities are now in a bear market, seems to have taken on a meaning that transcends reasoning and analysis and has settled into the domain of dogma. In other words, is there any real, analytical significance to the fact that certain indices have declined to such a point that they have produced a decline of 20% or more?

To some, the bear market bell has rung and, therefore, stocks are now banished to a land of expanding declines to all segments and sectors, as evidenced by last week’s thrashing of the leadership issues. Stocks destined for more losses is the given. But is it so that because some arbitrary line in the sand (down 20%) has been breached further and more extensive declines are a fait accompli?

Moreover, is it a done deal that equities are headed for sustained bad times when other important indices, such as the Dow Transports or the S&P 400 Mid Cap have declined to a meaningfully lesser degree?

To be sure, there are those who would argue that the all-knowing market has a "wisdom" that mere mortal investors would be reckless to challenge. Yet, here too, dogma supplants analysis and reasoning. For example, as noted in previous reports and blog postings, the current equity market climate is dominated by the shorter-term players (hedgies), whose time horizon ranges between milliseconds and weeks. Therefore, can it be assumed that the "wisdom" of the market resides with those whose interests are less oriented toward fair value analysis and more oriented toward what will produce the best short term results?

Investment Strategy Implications

There appears to be two ways to interpret current equity market sentiment. One is to say that stocks have crossed a line that now dooms future market action to much lower levels, with a broadening out of the pain to all sectors, styles, and regions. No place to hide. The current decline is the second leg of the bear and any near term rallies should be treated as selling opportunities.

The real economy underpinnings to this conclusion are numerous, everything from stagflation to $1.6 trillion in bank losses to $200 a barrel for oil and a global recession. Of course, such serious economic problems assume a static rather than dynamic environment. A cause and effect that lacks responses and their feedback effects that could alter the pre-destined outcome.

There is a real danger in buying into the dogma of benchmarks. As someone who believes more economic and investment pain lies ahead, it is hard to agree, however, with the thinking that it will all come to pass now that we have passed some magical, yet dreadful, line. Therefore, an alternate conclusion might be that the aforementioned real economy horrors will be forestalled for a variety of reasons, such as the $1.6 trillion bank losses is shrunk thanks to intellectual sanity rebuffing FAS 157 and the fair value doctrine. Or that $200 oil does not occur as the demand destruction that $140 oil produces caps further rises. Or perhaps oil declines to $100 as regulatory and legislative action force full disclosure of ownership interests in commodities (see yesterday's WSJ online article re pressure on the CFTC).

Timing is everything, it is said. And the timing of a large drop in equities seems more appropriate for a later date, more like the first half of 2009.

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