Home Stock Market Commentary Understanding Bear Markets Is The Key To Navigating The Stock Market In...

Understanding Bear Markets Is The Key To Navigating The Stock Market In 2023 – Mike Swanson

As we start a New Year for the financial markets it’s important to realize that 2022 was the year of a bear market for stocks. Everyone knows it’s a bear market, because the S&P 500 fell 19.9% in 2022 and the Nasdaq declined even more, falling 33.71%. But simply realizing that the market fell isn’t enough to understand what a bear market really is and how to navigate one.

You need to have a clear definition of what a bear market is for the concept to have any application for you and if you don’t have a clear of idea of what concepts like that are in the financial markets then you really have no game plan for what you are doing when you try to trade or invest in them. You’ll literally be trying to invest in the markets like a captain trying to navigate a boat in the middle of the ocean without a compass. You’d be just as well off to drop your money into a slot machine and pray you get lucky, but it doesn’t have to be that way if you arm yourself with knowledge.

Now markets move in cycles and it’s best to think of the market in terms of a long-term secular cycle (which typically lasts at least ten years) and shorter term cycles within that big cycle. You can have a long-term bear cycle within which there are shorter term 2-5 year bull cycles, or vice versa.

For instance, after the Nasdaq peaked in 2000, it went through an over ten year long secular bear market. Before that, the DOW went through a well over ten year secular bear market starting in 1967 that didn’t really end until 1982.

Sometime’s you’ll hear people say that a market correction is a drop of 10% and a bear market is one over 20%.

That isn’t a useful way of thinking as it leads one to just react after the fact.

I define a bear market as a bearish cyclical (2-5) year trend in the markets and I identify that trend by looking at the market’s relationship to its 150 and 200-day moving averages, which tend to act as price support during a bull market and price resistance in a bear market. This is simple “stage” analysis as described by Stan Weinstein in his classic book Secrets For Profiting in Bull And Bear Markets.

Remember, during a bear market, the market trades below the 150 and 200-day moving averages in a “stage 4” decline. The moving averages trend down during those periods and act as price resistance.

We started such a bear market trend last year and the last two major bear markets were in 2007-2009 and then 2000-2003.

If you take a close look at the price action of 2022 you’ll see that the S&P 500 rallied up to these moving averages in August and then in December and stalled out both times.

One thing different between this bear market and the two big ones that came before it is during those last two bear markets bonds went up and this time they are in bear markets at the same time that the US stock market is.

Now, what we know now is that the bear market is not over.

That tells us nothing about what the stock market might do this week or this month, but when it comes to the big cycle picture (which is what investors should focus on) we can know that the bear market trend is not over. So, if one wants to do a lot of investing with the intention to hold then one should wait until the bear market is over. In fact, one may even want to use rallies as a time to lighten up on positions and build cash reserves to use for later.

When will the bear market end?

No one can predict that ahead of time, but bear markets tend to end in panic selling washouts.

That selling activity coincides with spikes in sentiment indicators making extreme moves, such as the VIX options volatility premium indicator going above 40.

Bear markets also tend to go through psychological stages in how most people feel about them and how they try to deal with them.

When a bear market first starts few people realize it is happening and think the first decline is just a mere dip.

Then when the market rallies they think everything is just going back to the way it was in the last bull market, thinking it’s a “return to normal.” They’ll typically just try to buy the same stocks that were leaders of that last bull market even though it’ll be new stocks that lead the next one when it comes.

As time goes on and prices go lower, though, more people start to recognize that it is a bear market and in the second half of 2022 it was common to even hear people on CNBC say that it’s now a bear market.

But, while they recognize the reality of a bear, at that point most people just decide to try to hold on and ride things out, with the idea that they are investing for the long-haul.

The problem is that the bear market doesn’t end until there is panic and selling capitulation among the masses, and then even despair, as millions decide to actually give up on the market and put their money into something less volatile or that they deem to be safer for them.

Not once did the VIX get over 40 last year and incredibly last year saw a year of individual investors putting more and more money into the markets, averaging down with the conviction that the bear cycle would end soon and things would return to normal. The stock they bought the most ended up being TSLA, even though it was the worst performing stock in the entire S&P 500. It was a past leader of the last bull market and that is why they kept buying it.

But no VIX spike meant there never was a selling washout in 2022.

In fact, spikes above 40 in the VIX even tend to happen during 10-15% corrections within bull markets. You can see how there were five such spikes after the 2009 bear market and not one last year. To me that is one of the most incredible facts of 2022 and why it was a slow-motion bear market unlike one I had ever seen for the US stock market, and I’ve been following and trading the markets since 1998.

So, yes, I cannot overemphasize to you the importance of realizing that last year actually marked the start of what has been a slow motion bear market that has shown no sign of ending as we begin the first week of 2023. People get trapped chasing rallies when they would be better off buying into panic.

I think the best thing for most people to do is just to be patient on the stock market until the bear market ends and look for things that are in bull markets of their own, trading in bull cycles above their 150 and 200-day moving averages. Commodities are in a bull market and so are gold, silver, and mining stocks.

They happened to be the big winners of the 1970’s too.

As far the predictions go, what I am hearing is a lot of experts, that are leaders among both the bull and bear crowds, expecting a decline in the first half of 2023 that they think will setup a panic bottom end to this bear market and lead the way to a new bull market, which they think will be helped with inflation going down and the Federal Reserve lowering interest rates as a result.

I really have no clear opinion on what will happen in the first quarter of 2023, but I know that the market tends to fool the most people that it can. That makes me wonder if what we’ll see is the stock market actually hold up, go sideways, or even go up a little in the first quarter of 2023 and then simply have the bottom fall out of it in the second half of 2023. So, maybe the bear market will end in the second half of this year or the first half of 2024. That would match what the real estate futures market is saying about real estate prices.

But hey that’s just an idea and a guess.

Again the most important thing people need to know is that it’s a bear market in both stocks and bonds and trade and invest accordingly.

You see that’s not a prediction, that simply is what the trend is and navigating the markets means aligning yourself with the overall trend until it changes. Successful investing and trading is not about thinking in terms of predictions, but in terms of trends. Defining a bear market that way is the key to using it as a concept that doesn’t scare you, but one that helps you decide on what to do and actually take advantage of things when the time is right. Most market gurus try to provoke people using fear and greed to get people to make hurried emotional decisions, when what they really need is more understanding of what is happening.

To get my free stock market updates join my free email list by clicking here.