Buying into what could be a bear market

In my previous posting, I discussed buying into a bear market. In it I stated that in order to buy into a bear market, defined as a decline in the S&P 500 Index (the "Index") of at least 20%, I would need the fulfillment of two necessary conditions: 1) a sentiment indicator, Investors Intelligence Survey of Investment Advisors, must show at least 60% bulls and 20% bears; and 2) the Index must have retraced a Fibonacci number. I must admit a mea culpa. I meant to say "60% bears" and "20%" bulls. Some writers intentionally place an error like that in their texts in order to test the reader's attention span. I assure you that this was not the case.

Furthermore, I checked the percentage bears at the major market bottoms in 1974, 1982, 1987, 1990, and 2002. They were 67%, 61%, 46%, 56%, and 43% respectively. So if one were to wait for 60% bears before acting, one would have missed three of the five last major bottoms. Apparently, the "60% bears" rule isn't a good one. However, the above figures can serve as some input as to how high these figures are at major bottoms.

At this point in time, the percentage bears is 33%, well below levels of previous bear market bottoms. Furthermore, with a decline of roughly 10%, the current market action only qualifies as a "correction".

Let us assume that the high in the Index this year, 1553, is a bull market high. The bull market began in 1002 at a level of 775, and the Index has roughly doubled since then. The Index is up a total of 778 points. Reverting to Fibonacci numbers, 3/8, 1/2, and 5/8 retracements would result in levels of the Index at 1262, 1164, and 1067 respectively. I would probably begin buying at around 1200 in the Index if and only if the percentage bears was in the low to mid forties range.

Most Wall Streeters are hoping that this recent ten percent correction is all the downside we will have, and the current bull market will continue without an intervening bear. We must realize that Wall Street benefits far more in a bull market than a bear.

As bridge players say, "Let's review the bidding" with respect to where we are in the economic cycle. During the beginning of the new millenium, Alan Greenspan was worried that the U.S. economy, as a result of the internet stock market bubble, would go the way of Japan, which suffered a severe recession and a stock market that is still down more than 57% from its high EIGHTEEN YEARS ago! He wanted to let the air out of the stock market bubble slowly and cushioned the shock by lowering the federal funds rate to 1%, the lowest since the end of World War II. That policy was partially successful since the ensuing recession was mild. Unfortunately, with this low interest rate policy, he transferred the asset bubble from the stock market to the housing market. Home valuations are now about 40% higher relative to GDP than the norm.That is lower than the S&P 500 Index at its high in 2000, when it was selling at a P/E 100% higher than the norm. During the last several years, Bernanke has tried to let the air out of the housing bubble slowly by slowing raising the federal funds rate to 5.25 %.
The key question as to whether we have entered a bear market is whether the housing problem results in a recession in the U.S. If so, I am afraid that we have begun a bear.
It is possible that even without a recession, we can experience a bear if the current debt crisis results in the potential downfall of a major money center bank, investment bank, or hedge fund. The news of that problem might, in itself, create the buying opportunity that we have discussed above. Tune in!