New Column: CULT OF THE BEAR, part III

RealMoneyThe third and final installment of the Cult of the Bear series is posted at, titled  Part III: Making the case for Dow 6,800.

It ties together the top down, macoeconomics discussion (from Part I) and the cyclical/technical analysis (from part II), and makes the case that we are overdue for a 30% correction.

Here’s an excerpt: 

"One oddity of the move off of the prewar lows in 2003 is that the S&P 500 has yet to have a 10% correction. During the bull market period from 1996-2000, there were six corrections of 10% or more. Since the bottom on March 5, 2003, the S&P has sustained only three corrections of more than 6% and none greater than 9%.

Regular corrections serve a purpose for healthy markets: They cleanse the excesses that tend to develop, allowing further gains to proceed.

The lack of a 10% correction reveals high levels of complacency — something the CBOE Market Volatility Index (VIX) has been implying for quite some time. This creates "air pockets" — soft spots in the base of support that can potentially become more vulnerable to selling in the event of a test. As the 1966-1982 chart shows, broad trading ranges typically experience much greater than 10% corrections. Considering how regularly markets pull back and test support, the longer we go without that 10% correction, the greater the possibility of a steeper and deeper downturn.

The suggestion of a 30% fall in the S&P 500 has engendered widespread disbelief; investors broadly discount the mere possibility of such a correction. But as the nearby chart shows, there were five corrections that ranged in strength from 25% to 45% from 1966 to 1982. That averages out to one major correction every 38 months or so.

The S&P’s last major correction was a 33% drop from March to July 2002. That was 42 months ago — implying we are overdue for another steep decline."

Regular blog readers have recognize many of the arguments in the column.


Cult of the Bear III: Getting to Dow 6800,  1/18/2006 7:24 AM EST

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  1. B commented on Jan 18

    Love those people who are willing to step in and catch a falling knife when the sentiment is so bullish. No fear but plenty of greed.

    I am very conflicted with the future of the market. Correction followed by a good run? Statistically, we are near a very high probability correction. Frankly, I’d likely guess two corrections this year. One more mild than the other. Sort of odd perpective but have my reasons.

    So, investors are very bullish but the sentiment of the average joe American is awful. Where does this leave the market? Not at a top like we saw in 2000. More like a top we saw in the 70’s where the average joe thought the world was coming to an end? It is strange because I see all of the Wall Street professionals being bullish because of the wall of worry with international problems and globalization. So the Wall Street herd is positive because of all negatives. So the herd has taken the smart investor’s shtik? Hmmm…. It’s almost reverse-reverse psychology. Or the herd understands sentiment and is double twisting it. A double negative. Anti-sentiment sentiment is now what needs to be used to guage the markets? Double negatives are positive?

    It’s hard for me to analyze this situation because I was too young in the 70s to understand the environment, associated psychology and the markets. Barry, I’d be interested in your perspective and any analytics you use to determine how these issues are resolved.

  2. TonytheTiger commented on Jan 18

    I agree, this also happens short term. The SP hasn’t corrected since October. This last run up (today) just corrected to good support and the 38.2 percent mark. If this market has a strong upside, it should start soon.

  3. Tonythe Tiger commented on Jan 18

    On the other hand, today is Fed speak day. Not a good day to enter the market short term.

  4. tremor commented on Jan 18

    I too have referenced the market activity between 65-80 and come to the same conclusion, although not as grim I’m afraid. If history is any indication of future results, we should see a very volitile market going forward. I part from the authors view as to it’s intensity. Remember, average inflation during that period was around 6-7%, and by 1980 you could get a 20 year CD @ 20% interest. Give the average investor that alternative today and the market would be alot lower than 6800. I believe a fair P/E going forward could be a mean of 17-18X, with the obvious deviations. 30% correction from the current P/E is a little extreme though, especially given the fact that the last steep decline in stock prices came @ 27X earnings.

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