The 3 Stages of a Bear Market
This post is based on an interesting tweetstorm I had read a few weeks back. @JasonYanowitz wrote a thread with the tweet “There are 3 stages of a bear market. We just entered stage 2.” Though this thread was written from a crypto perspective, it is as much relevant to a bear market in any asset class.
The first stage of a bear market according to Jason is the unwind stage. During this stage the excitement from the bull market still exists. Things seem alright at this stage. It only feels like valuations have come down to interesting but realistic levels. We believe we are investing at a reasonable valuation. Companies continue business as usual. Investors continue to invest because the stock market continues to operate within a certain band and looks like it will go up. There is no stoppage of SIPs. In short, there is no panic yet. Only some weak hands have begun to sell. These are people who are often the first to sell and the last to enter again. They almost always end up paying taxes on gains, interrupt compounding and enter at a much higher level than their last exit point.
The second stage of the bear market is called the forced capitulation stage.
Jason tweets, “This is where it gets ugly. Narratives die. Prices fall 90%. Then another 90%. Layoffs across the board.
Mainstream media and cynics rise up in Stage 2. They laugh and say ‘we told you. We warned you.’
In Stage 2, any bounce will be immediately sold into.”
There is even a name for it. The Dead Cat Bounce.
Look at Netflix (I know I have mentioned this one several times – but it’s the right example – the best performer of the last decade).
Every bounce in this stock seems to be getting sold. We are constantly reading about layoffs from Netflix and the stock is now down Year to Date by 75%. The 52-week high of Netflix was $700 odd. It is $177 as I am writing this.
The lower the prices get, the louder the bears go. Many who do not want to sell end up selling. For example, if investors exit a fund, a fund/portfolio manager might be forced to sell. This actually creates a vicious cycle. The impact is higher on small stocks, and thinly traded securities. Imagine a situation where everyone rushes for the door all at once.
The third and final stage is called the Bottomless Exhaustion.
Jason writes, “After maximum pain comes maximum exhaustion. There are no bounces. There are no narratives. Prices consolidate sideways or slowly move down. It’s boring.”
Many economists even call this phase as time correction. This is a boring phase, generally an extended phase where nothing meaningful happens without a big drop in price.
This is the phase when most will give up. This is also the toughest one to survive even for many who manage to survive the first two stages.
Media will continue to find some narratives making it even more difficult to survive this phase.
I couldn’t think of a better quote than J P Morgan’s brilliant quote to write here – In bear markets, stocks return to their rightful owners.
However, this is a golden period for real investors. You won’t encounter this phase many times in your life even within bear markets ((remember – 70% of the time, stock markets are actually up).
There are times when things get worse before they get better. And better they will. It’s just that no one knows when and I mean literally no one (don’t waste your time looking for one either).
I have already written enough on Bear Markets including a Nano recently on how to survive one. So, I won’t keep harping on what needs to be done here but I would leave you with one deep thought from Morgan Housel.
He writes in his book “The Psychology of Money” – Most Financial Advice is about today. What should you do right now and what stocks look like good buys today? But most of the time, TODAY IS NOT IMPORTANT.”
Where the Sensex/Nifty is today is irrelevant or even for that matter where it will go tomorrow, next month or next year. Where will the Sensex/Nifty be in 20 years is far more important.
Napoleon’s definition of a military genius was, “The man who can do the average thing when all those around him are going crazy.” It’s the same in investing. The person who can do the average thing when everyone around her/him is going crazy will be an investing genius of the next several decades.
The question is “Are you that person?”