2 Phase Bear Markets

My Comments: This is a great overview that needs to be read and understood if you have money in the markets, especially retirement money. If you know how, you can find ways to make it grow when everyone around you is falling backwards. There is a link so you can see the great visuals and read all the writers comments.

Aug. 19, 2015 by Eric Parnell, CFA

• The specter has been rising that stocks may eventually break to the downside and threaten to enter into a new bear market.
• Stocks do not universally fall to the downside all at once, as the onset of a bear market tends to be more nuanced.
• Bear markets have two phases, which is a critical point for investors in positioning for whatever market environment may lie ahead.

The U.S. stock market has struggled to break out to new highs since late last year. And with the bull market already long by historical standards at a time when corporate earnings have stalled and monetary policy may soon be tightening, the specter has been rising that stocks may eventually break to the downside and threaten to enter into a new bear market. But if such an outcome were to come to pass, it is important to recognize that the market does not just simply fall to the downside all at once. Bear markets tend to be more nuanced. This includes the fact that they almost always have two phases. And this point is critical for investors seeking to position for any such future outcome.

The Two Phases Of A Bear Market – First Phase
Many investors have the notion that everything falls sharply to the downside all at once when stocks enter into a bear market. But history has shown that this is not the case. Instead, the onset of a bear market is often much more gradual. And this is true even if the initial catalyst that sparks the bear market is violent. This is due to the fact that investor psychology is something that tends to change only gradually over time, which is the key reason why so many investors only realize that they are trapped in a bear market when it is far too late to do anything about it. Such is the reason why bear markets typically have two phases.

The First Phase – 2000 to 2003 Bear Market

The first phase of a bear market is marked by a wide dispersion within the stock market itself. When a bear market first gets underway, it is frequently driven by a sector or industry that had previously been a key market leader. As a result, when the first major declines strike the market, the losses are often concentrated in this leading segment and investors view the initial pullbacks as long awaited buying opportunities that have finally arrived. As for the other segments of the market that were either moving steadily along or may have even been neglected, they often either continue in their previous trend or may even benefit, as capital rotates out of the leading sector or industry and into these more neutral to overlooked categories. As a result, many stock segments can continue to perform well for some time, even though a bear market is already underway.

Let’s reflect on the previous two major bear markets to illustrate how the first phase of a bear market typically plays out.

Back in the late 1990s, the technology sector was the extraordinary high flyer that propelled the broader market to dizzying heights. So when the bear market got underway in early 2000, it was the technology sector that was caught in the crosshairs of the decline. But what about the rest of the stock market during this time? What is often forgotten about the bear market at the turn of the millennium is how concentrated the losses were in the technology sector for much of the experience.

For the sake of illustration, let us first reflect on the nearly two-year period from March 24, 2000 when the S&P 500 Index (NYSEARCA:SPY) reached its bull market peak at the time through March 19, 2002.

With the bursting of the technology bubble, the once high-flying technology sector (NYSEARCA:XLK) was devastated during this time in losing -65% of its value. This helped drag the broader market, as measured by the S&P 500 Index, lower by -22% over this same time period.

Many segments of the market were actually performing well over this same time period. We’ll begin with the outright winners. Consider the performance of the consumer staples (NYSEARCA:XLP), financials (NYSEARCA:XLF), and utilities (NYSEARCA:XLU) sectors during this same time period. These three segments gained by +27%, +12% and +8% at a time when the technology sector in particular, and the broader market in general, were getting smashed. And these sectors were almost universally in positive territory for the first two years after the start of the bear market in March 2000.