Bear markets come and go

The trouble with bear markets is that you never know you are in one until the decline has reached a certain number like –16 pct or –20 pct or –25 pct. And then it's over.

I'm the guy who during the best of times believes the glass is half empty. This sign of pessimism is just the way I am. You see I have worked on both the sell-side and buy-side. And I know that for the owner of capital to win, the first job is to manage risk.

Over some 40 years in the market, I'd say I've been bullish about 75 pct of the time. But since that also means I have been bearish for about 10 years, the sell-side likes to call me a perma-bear. I don't mind.

I just don't like being around when the market's not bullish. I'd rather be sailing.

At Friday's close in the U.S., some last hour heroics by suicide bombers on a few trading desks helped the equity Bulls manage to hang on to their position, barely.

Next week will not be so kind.

Oh, there will be contrived stories out of Earnings Season, and fairy-tales that Katrina and Rita were merely passing storms in the night. But high costs of energy and rising interest rates, as well as prospects of Renminbi revaluation, will inexorably take their toll on the Bulls in the coming months.

In the stock market, the worst bear market experience I went through was 1973-1974. Much less painful was the one in 1981-1982. Both, however, were long-suffering terminal phases.

October 1987 – albeit a stunning event - was a learning experience for me. I discovered that trading decisions must be made resolutely, and that traders who do believe their own analysis typically sell stocks before they crash, even if they do it a little early.

From 4Q99 to 1Q03, which was a very long period of time, I learned the importance of holding dollars with no investment return when the protection of capital is more important.

During the summer of 1999, through into 1Q2000, I had prepared myself for the crash. I didn't know at the time if it would take place like '73-74 and '81-82, which were drawn-out affairs, or like '87 and (to a lesser extent) '91, which were abrupt.

My colleagues were oblivious; but during 3Q99, I knew – absolutely knew – to the point I wrote about it for half a year in my Internet Dow 30 Journal – that there was a bear market coming.

Early this year, at the beginning of the year and again at the start of March, I also forecasted bear phases that would pull the market down. I may have been voted off the island at the time, but I was right.

Of course, I didn't know at the time if the bear was a minor or major one. They turned out relatively unimportant.

Then last week I wrote some ominous words: "A fundamental shift is underway in capital markets. Due to the anticipated major weakness for both stocks and bonds in the weeks ahead, 80-pct cash weighting ought to be considered. Capital risks are now being fully factored into trading decisions, effectively for the first time since 2001. The S&P (1195) has minimal support at 1175, with the possible floor being 1100. The Dow (10292) has minimal support at 9800, with a possible floor being 9200."

Time will tell. But given the carnage I foresee, the Bulls should tell the Gnomes: "Forget the blindfold. Get on with the capital punishment!"

Following this purge of the market's biggest liars, I look forward to being a Bull for the ensuing four years in all capital markets (yes, even bond markets!).

Why is my long-term outlook so positive?

The Value Line estimates for each of the Dow 30 companies for revenues, earnings and dividends through to 2010 have been professionally prepared, with no axe to grind. They are free for all to read. I read them intently, as I have since my college days in the '60's.

After calculating the likely growth in the individual components, I arrive at only one possible conclusion for the Dow's aggregate performance; this index is likely to rise to about 14,000 by the time the Winter Olympics hit Whistler B.C. Feb.12-28, 2010.

That 50-pct gain in stocks would be a compounded annual growth rate of about 10 pct. Together with annual dividend returns of say 2 pct, the total annual return would be about 12 pct. Looking back for a half century at bull markets, that is certainly not an unreasonable performance.

But, before the market can go higher, it will go lower to 9200 from a cycle high of 10984 in March for a decline of –16.25 pct.

That's a very small bear, but it's what my crystal ball told me this weekend.