Benchmarking the Current Bear

Lessons from the Anatomy of the Bear by Russel Napier. I found the analysis interesting in context of the current state of the market.

Brief Summary

The author researches 4 equity bear market bottoms: 1921, 1932, 1949 and 1982. These years preceded spectacular stock returns. The author seeks to identify the factors that would have helped investors to identify the bottom and capitalize on the impending rebound.

Common factors present at all the bottoms: 

1. Presence of optimism and good news. Unlike the popular market belief that “it is darkest before dawn”, reasonable amount of good news and optimism existed as evidenced by WSJ articles around each of these episodes. Investors just chose to concentrate on the bad news.
2. The best valuation parameter for identifying extreme undervaluation of equities in each of these episodes proved to be the q-ratio. The P/E ratio did not appear useful given extreme uncertainty surrounding earnings around these turning points. 
3. Commodities bottomed first and the copper price upturn figured an important harbinger of subsequent stellar market performance. Surprisingly, this point held sway even in the 1982 episode when a rise in commodity prices could have un-nerved investors given Volker’s inflation fight.
4. The bond market led the recovery.  Corporate bonds rose first, followed by stocks.   
5. A final sell-off on low volume. This theme also works against the common belief that markets often bottom out with a final capitulation on high volume.
6. Liquidity analysis did not help in any of the cases. Broad money/credit trends did not make the task of calling the bottom any easier. If Fed rate reduction were taken as signals of easier liquidity, the market fell further from that point.

 

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