Three Bear Market Phases: Denial, Panic, Capitulation ~ The Risk Averse Alert

Sunday, May 17, 2009

Three Bear Market Phases: Denial, Panic, Capitulation

Somewhere some time ago I read an interesting description characterizing the three phases of a bear market you see in this post's title. Prolonged periods of selling in the stock market typically possess these identifiable qualities at various points along the way.

Considering these, the first two phases — denial and panic — appear to have passed since the stock market's October 2007 top...


"Denial" accompanied belief the credit crisis would be contained to the mortgage market.

"Panic" occurred when constrained capital markets brought certain lynch-pin enterprises (AIG, FNM, FRE) to the brink of extinction.

When we saw something like 86% of all NYSE-listed issues trade at 52-week lows last October, a credible benchmark measuring the depth of panic was revealed. A "sell first, ask questions later" spirit surely prevailed. There never was clearer evidence sheer panic had overtaken activity on the stock market.

Which, of course, is not to say the stock market's collapse has ended, because now comes the final phase in a bear market: capitulation.

This is when stocks are sold because, whenever they go up they are unable to stay up, so an increasing segment of some vested interest simply gives up and joins the selling...

SPX weekly

Over the course of the next five years "capitulation" might play some larger part while the stock market effectively forms a bottom. This simply might be the result of equities — common stocks — becoming a less attractive asset class. Likewise, risk might be perceived less in some tranche of the mountain of debt that must be floated to keep a bankrupt, securities-based financial system from sinking. In other words, stocks simply might be shunned for some perceived safer alternative.

Vote this leading stock market expert at FeedTheBullSo, in the period ahead it will prove useful discerning the extent to which panic accompanies any stock market decline to new bear market lows. Don't be surprised if comparisons to underlying conditions at last October's worst are only nominally improved.

And what if conditions weaken? Could some penultimate stock market panic still be pending?

Right now, I don't think so. Cooler minds anticipate capitulation. Of course, time will tell...

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Analysis centers on the stock market's path of least resistance. Long-term, this drives a simple strategy for safely investing a 401(k) for maximum profit. Intermediate-term, investing with stock index tracking-ETFs (both their long and short varieties) is advanced. Short-term, stock index options occasionally offer extraordinary profit opportunities when the stock market is moving along its projected path.

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