Bear market won’t be hibernating anytime soon

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In a speech last Tuesday, Fed Governor Janet Yellen became the first senior member of the Federal Reserve to proclaim that the U.S. economy is in a recession. 

Last fall, and again in January, I outlined why I expected a recession would begin this year, and why it would probably be “the worst in 25 years, much worse than the mild recessions of 1991 and 2001, which most people remember as typical recessions.” 

Wall Street and the Federal Reserve said otherwise. Until just a couple of months ago the majority of economists, and the Federal Reserve, assured Main Street and investors that we were in for slower economic growth, but not a recession. Over the summer, assurances continued that only slower growth, but not a recession, was all that lay ahead. 

Small business owners and folks on Main Street knew better, and thought we were already in a recession. But as it had with the problems in the housing bubble, banking crisis, and bear market in stocks, the Fed also kept its head in the sand (or was it in the clouds) regarding the economy. 

Then two weeks ago, in a move coordinated over a weekend with global central banks, the Fed rushed out with an emergency rate cut to help stimulate global economies, and the possibility of a recession entered Fed Chairman Bernanke’s vocabulary. 

Aimed at calming global markets, that emergency rate cut seemed to have the opposite effect, indicating to investors that central banks were panicked, that the situation is worse than was thought. The Dow plunged 995 points over the next three days. 

The Dow has since recovered most of that three-day decline, amid extreme volatility. But the expectations for the economy have darkened. Not only has the consensus opinion now become that the U.S. is already in a recession, but that it is global, worsening, and will not be brief and mild as were those of 1991 and 2001. 

In my January outline, and repeated a few times since, I said it wasn’t rocket science to believe the worst housing meltdown in 30 years, the worst financial system crisis since the Great Depression, the bursting of the worst consumer debt bubble ever, the greatest government debt exposure in history, and a few other ‘worst ever’ conditions, would result in a worse than usual economic recession. 

The mild recession in 1991 lasted nine months and the unemployment rate reached 7.8%. The recession of 2001 lasted eight months, and the unemployment rate reached only 5.8%.

The two previous recessions of the last 25 years were those of 1973-75, which lasted 16 months, in which the unemployment rate reached 9.0%, and that of 1981-82, which also lasted 16 months, and in which the unemployment rate reached 10.8%. 

If we are just entering a similar 16-month recession, it would not end until early 2010. The unemployment rate, already 6.1%, would likely wind up being similar to in those previous more serious recessions. 

That ties into a few of my other forecasts, that the stock market is in a serious bear market, which will see its low for this year in the October/November time-frame, but will not see its final low until 2009 or 2010. That, like the bear markets of 2000-2002, and 1973-74, this one will also last for upwards of three years. 

Looking back to the bear market of 2000-2002, the S&P 500 declined 50% in total, the decline interrupted by three bear market rallies, of 17%, 19.5%, and 17.5%. In the bear market of 1973-1974 the S&P 500 declined 45.2% in total, the decline interrupted by two bear market rallies, of 17.4% and 13.4%. 

So let’s refine my forecast for the current bear market a bit more. The market has become much more volatile in this bear market – like you don’t know that, given the frequent 5% to 10% one-day moves in both directions. And its initial decline this year has been more substantial, to more deeply oversold conditions, than the declines in the first year of the 2000-2002 and 1973-74 bears. 

So I expect the bear market rallies will be more substantial, probably as much as 30% or more.

If I am correct with the forecast of a low this year in October/November, possibly already seen, and then a resumption of the bear market next year, it follows that it will likely be as important next year as it was this year for investors to become comfortable positioning for market declines. Bear-type mutual funds and ‘inverse’ exchange-traded-funds are likely to again be the source for larger and easier profits than the bear market rallies. 

But short-term the market is potentially oversold, investor sentiment is at record levels of bearishness, and fear among investors and on Main Street is similar to that seen near significant stock market lows. 

So, we should soon see if the second half of my prediction for this year will also come to pass, after the low in the October/November time-frame for a significant rally to year end.

We are watching our charts and buy/sell indicators closely with that in mind.

Sy Harding
Street Smart Report

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