April 2009: Bear Market Bounce or New Bull Market?

Bear Market Bounce or New Bull Market?

Seat belts and Dramamine were advisable last quarter.  The stock market reached its highest level for the quarter in the first week of January and then proceeded to plunge 28% to its lowest level in 12 years, extending this bear market’s peak-to-trough decline to 57%.  Of course that wasn’t the end of it.  The market went on to rally 23% by March 26, just 13 trading days from the March 9 low.

Have we seen the ultimate low point for this bear market?  Early March certainly had the “feel” of a low point.

Since the financial crisis hit full force last September, the stock market posted three significant rallies of 18%, 24% and 23% through the end of March (see Chart 1).

Unfortunately, the first two rallies were followed by even bigger declines that resulted in new bear market lows.

Will the most recent rally that started in early March mark the beginning of a new sustainable bull market, or will it, too, fade in the coming months?  No one knows (yet).  The verdict is still out.  It could go either way and only after the fact will it become “clear.”   Although there is no shortage of predictions about which way the stock market is headed, the truth is that no one can say for sure if the next move in the stock market will be up or down.

Note the two trend lines shown on the chart below (Chart 2).  The lower line (red line) fits the starting point of the three rallies since September.  Each one starts at a lower level than the preceding rally.  The upper line (green line) fits the ending point of each rally.  In each instance, the rally ended at a lower level than the rally that preceded it and the declines ended lower than the preceding decline.  In stock market jargon that’s a trend of “lower highs and lower lows.”

These trend lines do not necessarily mean that the next move in the stock market will be downward to a new low point.  Trend or no trend, the stock market will eventually bottom out (if it hasn’t already) and a new bull market will take over.  However, as investors it would be a mistake to assume that the most recent low point (S&P 500 closed at 676 on March 9) is the final low point for this bear market.  It would also be a mistake to assume that it is not the final low point.

During the last few days of March, the Standard & Poor’s 500 stock market index climbed above the upper band trend line (green line) in Chart 2.  Even more encouraging, the S&P 500 rose above its 100 day moving average (see Chart 3 below) for the first time since last June.  These are both encouraging developments.

Irrespective of what we would prefer or hope for, the fact remains the stock market could go either way and we should invest accordingly.

Here’s how we view it.  If we think that the most recent rally really is the beginning of a sustained stock market recovery, we can be venturesome and allocate a larger amount of portfolios to stocks.  If we make that assumption and we are wrong, we will lose capital.

On the other hand, if we think this is not a sustainable rally and it will be followed by another decline, we can elect to be cautious, maintaining our current defensive portfolio allocation with a reduced allocation to stocks.  If we make this assumption and we are wrong we will lose opportunity.

Opportunities are much, much easier to replace than capital.

At this juncture, we believe that the temporary defensive adjustments we have implemented for portfolios is the right thing to do for our clients given the backdrop of continued extreme daily price volatility, the uncertainties surrounding the impact and effectiveness of federal programs to rejuvenate credit markets and the economy, and our conclusion that the stock market could go either way from here.

Being Different

You can’t follow the crowd and expect to do better than average.  Any quest to be above average requires being different.  Being different requires a willingness to be out of sync with the crowd from time to time.  In turn, that will entail occasional periods of underperformance. 

We realize that it is never pleasant to underperform, even if only temporarily.  However, we accept it as a necessary part of successful investing.  We are optimistic that despite being out of sync in the short-term, the long-term picture will be quite favorable.

A Reminder

As the saying goes, “This, too, shall pass.”

In prior years we often reminded readers that the good times would not last forever.  History shows that good times never continue uninterrupted.  We also need to remind ourselves that the bad times do not last forever, either.  Today’s problems, challenges and concerns will soften over time and the pendulum will swing the other way toward resolution, stability and prosperity.  And that, too, will be revealed as time passes.

Thank you for your continued support, confidence and patience.  ***

Greg Schultz & Bruce Grenke
© 2009 Asset Allocation Advisors, Inc.