Posted by on Oct 11, 2011 in Articles & Advice, Blog, Columns, Featured, Video |

Image Credit: Christophe Vorlet

By Jason Zweig |  October 8, 2011

On Tuesday, when the Standard & Poor’s 500-stock index sank below 1100, market pundits were champing at the bit to declare that a bear market had officially begun. They had to eat their words before they could say them, as the market promptly jumped up by more than 5% by week’s end.

Those who think they can predict bear markets, and anyone foolish enough to listen to them, might be humbler and wiser if they realized that the term “bear market” has been in flux for a century. Investors who rely on labels like “bear market” to guide their decisions are clinging to conventions with no real meaning.

There is no such thing as an “official” bear market. For convenience, based on a rough consensus among analysts, The Wall Street Journal and others define it as a 20% decline from a closing high to a closing low on the Dow or the S&P 500.

But that definition is surprisingly new.

The term “bear,” for someone who profits when stocks fall, dates to the early 1700s. “To sell the bear’s skin before one has caught the bear” was an early description of a short seller, who borrows shares and then sells them, hoping to buy them back at a lower price. “Bear market” originated from the same metaphor, but the term was “seldom used” before the 1880s, says lexicographer Barry Popik.

The book “The ABC of Wall Street,” by S.A. Nelson, published in 1900, didn’t include “bear market” in its glossary. William C. Moore’s 1921 book “Wall Street: Its Mysteries Revealed, Its Secrets Exposed” defined “bear market” only as “one in which selling preponderates and prices decline.”

From the 1920s through the 1940s, the Journal regularly described even a 4% decline in a single day’s trading as a “bear market.”

Until at least the 1940s, many analysts believed a bear market occurred whenever the three major Dow averages—the industrials, the railroads and the utilities—all hit new lows.

In his book “Bear Markets: How to Survive and Make Money in Them,” published in 1964, investment adviser Harry D. Schultz listed “all probable bear markets” up to that point in the 20th century. Of the 17 he identified, four fell less than 20%: 1923 (nearly 19% in seven months), 1926 (17% over two months), 1953 (14% over nine months) and 1960 (18% in 10 months). Mr. Schultz also counted the 1934 decline, when the Dow lost 24% over nine months, but noted that it was “rarely included among bear markets” by other experts.

In 1990, an article in the Journal noted that “Investment pros usually define a bear market as a fall in stock prices that lasts at least two months and drags down prices at least 20%.” More recently, the Journal has dropped the “at least two months” part. (That makes the 23% drop in the Dow on Oct. 19, 1987 a “crash” rather than a bear market.)

In short, the definition of “bear market” is a chameleon. But that ever-changing nature reflects what happens in the real world. Depending on when you start counting, stocks are always in either a bull or a bear market. Oddly, in fact, they are often in both at once. Over the five years ending Sept. 30, for example, U.S. stocks have lost an annual average of 1.2%, and they fell 13.9% in the third quarter of 2011; those are bear markets in spirit, regardless of the 20% metric. Over the past 20 years, however, U.S. stocks have gained an annual average of 7.6%—a bullish rate of return that still doesn’t feel quite like a bull market.

Slapping the “bear” label onto a market that is down 20% makes it feel more predictable and controllable. But that’s an illusion; anything can happen. Stocks could keep on dropping until they lose 89%, as they did from 1929 to 1932, or they could change course instantly and go straight up. The declaration of a bear market tells us a little about the past, nothing about the future.

What you can know is that declining markets are good—not bad—for savers who have the luxury of steadily accumulating stocks at depressed prices, so long as they have the guts to hang on. They should rejoice over bear markets.

Conversely, a falling market is bad for retirees, who face the necessity of having to wring cash out of continually shrinking portfolios. They should fear bear markets.

But in either case, you should stick to your plan instead of scrambling to change your strategy just because an index crossed some arbitrary numerical threshold.

Source: The Wall Street Journal


Related video: