11/17/17

Preparing for Bear Market Operations

The current bull market began in March 2009. In this post, Chicken Little is preparing for his first Bear Market Operation in many years. This post is similar to the successful "Criteria for Bullishness" article for 18 months ago.

The premise of Bear Market Operations is that there will be a massive, historic drop in price for all risk assets - stocks, real estate, and (almost) all bonds. Most people will be financially ruined by this bear market. 


A  Plan for Waking the Sleeping Bear


Asset markets tend to move in ways that hurt the most people. The market sets people up for failure by behaving consistently in one way for long periods of time, and then changing character dramatically and rapidly. 

By way of example, the 2007-2009 financial crises involved a broad, but fairly shallow, decline in housing prices. Using official, US Government data from the FHFA, the decline in national housing prices was less than 20%. A 20% decline is not even a remarkable hour for the asset of 2017 -- Bitcoin. 


Why did a modest decline in housing prices cause such financial pain? The answer is that there was tremendous leverage in the housing market. Decades of rising housing prices set people up for levered failure. 

The stock market is setting people up for a similarly painful adjustment. Just as history rhymes, but does not repeat, the change in the stock market will not be the same as the change that occurred in the housing market, but it will be similar. 



What is the one lesson learned from the stock market since 2009, and, perhaps since 1800? The lesson is i) never sell into a decline, and, relatedly, ii) buy the dips. 

Given that all US stock markets are at or near all-time highs, every dip in the history of the world has been a buying opportunity. 

BF Skinner's pigeons would buy the dips


I believe the market will change its character and punish people who buy dips. Asset prices will fall, dip buyers will rush in, and the decline will halt for a period of time. However, in contrast to all recent experiences, these early halts will be false bottoms. We will experience a series of steep declines with halts interspersed, and some strong rallies. This will continue until most people are devastated, and vow to never buy a stock again. 



Time to violate the buy the dip rule


What is the correct strategy for chickens? i) do not buy the dips, and ii) be ready to sell one of those false, temporary bottoms. The first milestone in Bear Market Operations will be a 10% decline in the US equity market from its peak. More when that occurs.




2 comments :

  1. I have a lot of sympathy for this view. However, one key difference with the last couple of cycles is that I haven't been able to identify the leverage. Pre-2007, it was really obvious, so maybe that example just makes me spoiled.

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    1. Thank you Joshua,

      What do you think of total debt figures? Succinct summary here: https://goo.gl/DF7Krd

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