Is There an Embedded Lesson About Bear Markets In These Predictions?

The first day of trading after the long holiday weekend left stock investors a tad poorer. The losses that have marked recent weeks continue. Today the Wall Street Journal reports that investors are piling into ETFs that buy low-volatility stocks. So-called "buffer" ETFs have attracted money as well. These try to limit losses with the use of options.

So has the investing public given up on stocks? Maybe. But don't bet on it. Investors remain as fickle and irrational as ever. A good reversal in stock price trends may very well turn the tables and awaken the bulls.

But what about the theor that we're already in a bear market? If that's true, how can a bull rule the day?

Simple questions. But the answers aren't so simple. Two recent analyses we reviewed - both by some pretty smart fellows may help us here. Let's see if there's an embedded lesson about bear markets in their predictions - predictions which, on face value, seem to contradict each other.

Based on the first author's "cycle theory," we can expect a bump in stock prices, possibly through July. At that point, we'll see things go south - worse than they did this past fall. Even though such collapses typically happen in the months of September-October, this fellow's thinks we'll bad things begin in July.

As if that weren't enough, the longer-term rediciton is that stocks will work their way down until 2022. That implies a 3-year or so bear market. At one point, this same gent predicted Dow 5,000. That's a pretty disastrous collapse, even over three years. (I'm not sure if he still holds to that prediction.)

Balanced against this scenario, we have a second analysis. It enthusiastially pronounces that the great "Melt-Up" theory is still fit as a fiddle. Yep, despite the recent negative action, we find no change to the prediction that stocks will rise in a frenzied, exponential leap to the moon, as they did in 1999.

These starkly different predictions contradict each other, right? Well, without getting these fellows together in a room, we don't really know for certain. In lieu of asking them directly, depending on how you interpret their comments, it could that instead of opposing each other, they may both be right.

For example, if we look back at 1999, we find that the S&P, after hitting its highs, fell around 42% over the next three years. But before hitting those highs, there was a sharp drop in stock prices. Fast forward to today. Maybe we do get a drop in the late summer - early fall. Then, after that, maybe stocks take off. Stranger things have happened. And - for whatever reason - maybe that fickle, irrational public decides they're tired of missing out on stock market gains - as so many have during this long bull market - and pile in. Piling in, they drive prices to the moon: the Melt Up.

Of course, you probably know that after a Melt UP comes the Melt DOWN. Sounds logical, except that the downward price action doesn't typically happen in the short time frame of the Melt Up. As in 2000-2002, it could take a bit of time. A fall from whatever the highs might be at the time would mean losses of thousands of points on the Dow, a thousand or more on the S&P. Extending over three years would be a horrendous experience if you're sitting on stocks. And most of those who rode the market up in the Melt Up would likely have their guts ripped out in the downturn.

The embedded lesson about bear markets: When prices fall, they may very well take their time. And they won't go straight down. They could have sharp spikes even some that get close to the high once or twice, before collapsing again. Watching all this, investors become mesmerized, like deer in headlights, and do nothing - until its too late. Indeed, that happened 2000-2002. Maybe guts ripped out isn't a good description. It's more like having surgery every few months to remove a gut or two.

That's how these two seemingly differing views can be reconciled, providing us with an embedded lesson about bear markets.

Not very encouraging, is it?

Then again, the fellow who's predicting the drop to begin in July has said a new bull begins in 2022. That means the world will not come to an end, after all.

Between now and then though, lots of drama and consternation will rule and cause most investors in stocks to - as they have so consistently throughout history - lose their shirts.


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