Secrets Of Success; One man's bear market is another's bull market

One thing I have learnt over the years to be cautious about is the distinction between the phrases "bull" and "bear" markets. The phrases are bandied about with such abandon they have almost ceased to have real meaning in common parlance (yes, I plead guilty to this charge myself). It is not a trivial matter: mistaking a bull for a bear market, and vice versa, can be confusing, and maybe even cause you to do things you never intended.

One thing I have learnt over the years to be cautious about is the distinction between the phrases "bull" and "bear" markets. The phrases are bandied about with such abandon they have almost ceased to have real meaning in common parlance (yes, I plead guilty to this charge myself). It is not a trivial matter: mistaking a bull for a bear market, and vice versa, can be confusing, and maybe even cause you to do things you never intended.

Assume for a moment, for example, that the market lows we saw in March this year do turn out to hold for some time. For several reasons, a lot of which are to do with the electoral cycle in the United States, it is possible that the US stock market, as represented by the S&P 500 index, could power up to about 1200 over the next year, in other words, to touch a new high some 50 per cent above its recent lows.

I know of seasoned market practitioners who think this is a plausible scenario, given the Federal Reserve's concerted efforts to pump whatever amounts of liquidity into the system it takes to try to avoid deflation. I have a lot of sympathy with this view, which I would guess has a reasonably high probability (though the actual outcome is inherently unpredictable and dependent on events between now and then about which we have no knowledge).

A market that rises 50 per cent within, say, 18 months is a bull market, wouldn't you say? Well, not exactly. In the eyes of purists, it is not really a bull market unless it marks a decisive break in what the pundits have already identified as the preceding "secular bear market", or unless - these are variations on a similar theme - it is based on "real long-term value" or until "fundamental structural problems" in the economy have been resolved.

The trouble is that these conditions may not be achieved for a long time, and even then are usually identified only in retrospect, with the benefit of hindsight. There were scores of smart professionals who started saying the great bull market on Wall Street was over as early as 1997 and 1998, and in some ways they were right: it was only one sub-segment of the market that subsequently took off and imploded in the now notorious bubble. Shares in many well-known companies in unfashionable sectors did peak in 1998, but many of these premature bears were pilloried for their views at the time.

So what then do you say to young and inexperienced investors who started buying shares in October 2002 (in the United States) or March 2003 (over here) and find themselves up to 50 per cent better off next year? They will take some convincing that they haven't lived through some sort of bull market, and if they haven't, they might well ask you, what is it that they have been living through? The truth of the matter is that the terms bull and bear markets mean whatever the speaker wants them to mean. Some unfortunates who finally opted to buy shares for the first time at the height of the bubble will still be down on that investment for years. To them, in all probability, it will still seem like a bear market, whatever the headlines may tell them.

This is part of the phenomenon known to psychologists as "anchoring", the natural human tendency to cling to some price or market level at which their experience began, and to judge all future changes against that benchmark. There is, of course, a reason why your buying price for a share may be an important factor: it determines whether or not you are liable to capital gains tax when you sell. But it says nothing about what will happen to the future price of what you own.

The market, in the time-honoured phrase, doesn't know and doesn't care the price you paid for what you own. (The tax factor can become a cruelly distorting influence on investor behaviour, as for example with trustees who never sell anything in the fund which they oversee if it has gone up, for fear of triggering a capital gain tax liability. This is a policy that must have cost many trust funds untold amounts over the years). In practice, all market participants' views about what will happen next are deeply coloured by their experience and their history in the markets. One man's bull market can easily be another man's bear market. What professionals who go on about "secular" bull and bear markets tend to mean is that even if prices do rise sharply over the next six months, they could well fall below the present market level over some longer period.

This may be an interesting point of view, but I have never been totally convinced that it is useful, other than as a mechanism for self-justification after the event. Stock markets are volatile, which is why they offer attractive long-term returns. There are times when the balance of probabilities in favour of a particular outcome over a particular time-frame is less than at other times. Shares were a poor buy for long-term investors in 1999-2000, just as many Government bonds are a poor long-term buy now. But in both cases there was money to be made for those happy to run the risk of buying at the tail-end of the bubble and selling before the peak actually occurred (a technique also known as the "greater fool" theory).

As for property, the distinction between bull and bear markets is complicated further because the market in houses, unlike that in shares, can dry up. If there was an hourly market made in houses like the one you own, it is a safe bet nobody would still be saying the property boom was still intact. If nobody wants to buy your house for more than 75 per cent of what you think it is worth, it isn't worth what you like to think, but who wants to shatter such comforting illusions?

davisbiz@aol.com