9 July 2008

Its a supercycle Bear market

Another permabull story is emerging, which alone should be enough to convince you that the bear market they're trying to rationalize is not nearly over.

It goes something like this.

Yeah, well, the stock market decline may have crossed over 20%, which means (we missed) it's a bear market, BUT since the average bear market decline has only been about 30% it's time (again) to anticipate a bottom.

Well, there have been 28 declines getter than 20% since 1870, and their median has been 35.7%, which is about twice 20% on a compounded basis. (the log of 1-0.357 divided by the log of 1-0.200 equals 1.98)

That means the bear market decline so far is really has only been half of such average bear markets. Of course, the second half of those declines have much more negatively impacting fundamentals with many times more associated investor pessimism as does the first half.

But there's more with this kind of “expect the average” reasoning.

When the stock market declines 35.7%, which our work shows it surely will, then this “expect the average” reasoning would suggest a 46.9% decline, since that is the median of the 14 greater than 35.7%-sized previous declines since 1870. A 35.7% decline is equivalent to 2.84 compounded 20% declines.

And when the stock market decline reaches 46.9%, which our work shows it likely will, then expectations should be for a 49.2% decline, which is the median of the six greater than 46.9%-sized previous declines since 1870. A 49.2% decline is equivalent to 3.04 compounded 20% declines.

And when the stock market decline reaches 49.2%, which our work also suggests it likely will, then expectations should be for a 50.5% decline, which is the median of the three greater than 49.2%-sized declines. A 50.5% decline is equivalent to 3.15 compounded 20% declines.

The final extension of such “expect the average” is that when the stock market decline reaches 50.5% , which not-so-coincidently was the previous bear market decline from 3/24/00 through 10/10/02, the expectation then should be for the only larger decline since 1870: the 86.0% second downleg in the Great Depression Supercycle Bear Market from 4/17/30 to 7/8/32. Surely the mood of “irrational complacency” will succumb before then.

So the question is at what point will the majority of permabulls stop extending this “expect the average” reasoning to continue rationalizing no panic selling and looking for a near-term bottom like they are today? Although inevitable time-extending rallies will prolong false hopes, we expect they will abandon it before the stock market declines a second compounded 20%, or a cumulative 36% decline (1 minus 0.8 times 0.8).

Our work suggests the current 20% decline is only about the first third of the second downleg in what we call the Supercycle Bear Market, the “irrationally exuberant” echo-mania bust, which we fundamentally and technically quantify as an eventually deflationary economic Supercycle Bear Market Period.
In order to technically “base” and accommodate fundamental aftershocks from the current recession becoming very long and thus ultimately severe, we expect the Supercycle Bear Market Period will probably persist several years longer than the Supercycle Bear Market itself –probably through about Oct 2014. During the interim we expect the Supercycle Bear Market will most likely eventually decline at least a 50%."

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