Clearly, a bear market definition is required before these pages can help to offer suggestions about how to protect capital or even profit in such circumstances.
Without any fuss or bluster, lets get straight to it. A bear market is depressed or declining. In fact, my Oxford English dictionary defines a bear market as, "a market with falling prices". Both seem equally good.
It must go without saying that it is possible to have a bear market in almost anything. The value of property, precious metals, commodities, advertising and almost any other active business or financial sector that can be thought of, can go down - including the value of stocks, bonds and other financial instruments.
From this, it is then quite easy to define a 'bear' - and we aren't talking about the grizzly kind...
Once again to the Oxford English dictionary, "a person who sells shares hoping to buy them back later at a lower price" or "to speculate for a fall in price". Both seem reasonable enough, but we contend that perhaps these definitions do not quite go far enough.
Therefore, we have found a possibly better suggestion. In his groundbreaking book, "After A Crash: Bear Market Money Making", trading and financial legend Harry D. Schultz suggests that a 'bear' is "an investor or trader who believes the trend of stock prices is down and trades or invests with that trend by selling his stock and / or selling short".
Returning again to 'Uncle' Harry, in his most recent (1988) version of the book, he lists the bear markets in the United States between 1900 and 1987. In total, he suggests that there were actually 21 in 79 years.
He averages this to be a bear market every three and three quarter years, suggesting that for a 'long-term' investor, they "are frequent enough to be impossible to avoid them or to avoid their losses. Thus the investor must try to understand bear markets better. Otherwise, the profits from the previous bull market are usually wiped out."
It is worth pointing out that the book has an American slant, so the numbers above relate to the NYSE and Dow Jones.
Everything points the same way
It is also worth adding that negative market trends rarely happen in a vacuum and the overall economy is often moving in the same direction. This means that if the stock exchange is falling then it is likely that the national economy is, or soon will be, in recession. Should there be a stock market crash, then it is almost impossible to imagine that the economy will not be impacted.
Typically, the origin lies within the bull market that came before it. Often borrowed money is a feature if there is a Wall Street crash. Before the Great Depression, the bull market of the "roaring twenties" sucked in money from almost every class of the population, all hoping to get rich, many using margin buying techniques (meaning that they borrowed money for a large proportion of their investment capital).
As the margin calls forced more and more people out of their holdings, each bear market rally sucked in new money from investors that thought the stock exchange must have bottomed out. Of course, wave after wave of investor putting new money into the Dow Jones was wiped out.
In circumstances like this, where a long recession or depression is in place, the entire economy is put through a wringer, forcing down property values, making millions unemployed, destroying wealth in all classes of people and forcing bankruptcy after bankruptcy. Any bear market duration longer than a few quarters will really start to bite both public and private finances.
In contrast, the 2008 bear market and stock market crash was related to too much borrowed money in a different sector of the economy - home mortgages. However, this borrowing had made it's way onto the balance sheets of investment banks (such as Bear Stearns and Lehman Brothers) because they were trading, insuring and selling other people's debts.
As the world seemed to collapse in late 2008 there were very few bear market rallies to suck further wealth into Wall Street - the wealth was already there, being sucked downwards day by day. As has since been widely reported, there were some wise hedge fund managers (such as John Paulson) who bet the other way and made billions of dollars in profit, by successfully forecasting the coming problems.
He makes some interesting philosophical points, essentially asking whether an economy could really function properly if everyone invests "long only" as the vast majority of private investors and pension funds do. As he puts it, if the world turns upside down and prices drop through the floor, at least someone (the short seller) will have made a profit. This is undoubtedly the libertarian in him.
However, the financial crisis of 2008 and the eurozone crisis that followed has forced us to ask these questions once again. A number of countries imposed either restrictions or outright bans on selling short, especially in the banking sector. While these moves reigned in the speculators for a time, it did remove an element of realism from the markets, enabling weaker banks to survive when they might not have under different circumstances.
Such government intervention makes a great deal of sense if you are in government and are trying to stop an economic collapse. For the aggressive traders and fund managers of this world it is a constraint on their money making abilities. It is difficult to argue, however, that these temporary trading restrictions were anything but in the public interest.
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