Some Lessons from the Biggest Bear Markets

The three biggest bear markets in U.S. history:

1929-1932: Dow Jones Industrial Average declines 90%;

2000-2002: The Nasdaq Composite declines 80%;

October 2007 – March 2009: S&P 500 declines 58%, 

The Nasdaq Composite drops 56%, R2k corrects  60%.

Some lessons from the biggest bear markets in history:

1. There are multiple 20-30% relief rallies which offer great trading opportunities. Protect your profits because most relief rallies don’t last long.

2. The rallies towards declining 50 and 200dma end up being great short opportunities.

3. A relief rally followed by a break below a 50dma is a great short opportunity.

4. Bear markets last longer than most expect. Many long-term investors eventually realize that even the stocks of the strongest companies are not immune to >50% decline. Many get exhausted and sell for big losses because they cannot stomach the drawdowns at some point.

5. Bear markets provide live-changing trading opportunities while they last and live-changing investment opportunities when they end.

6. New bull markets start with a constructive setup in the major stock indexes above their 50-day moving average which is above a flattening 200-day moving average. 

7. New market leaders make new 52-week highs ahead of the indexes.

8. Any company that is priced for bankruptcy during a bear market that survives turns into a 20-100x winner during the first 1-5 years of the recovery (new bull market). 

9. The stock market is not a place, where for one to win, another has to lose. It is a place driven by cycles – a period when almost everyone is a winner is followed by a period when almost everyone is a loser.

10. Liquidity tends to magically disappear during bear markets when people need it the most to exit.

Momentum Monday – Trading In A Bear Market

The charts in this video are powered by MarketSmith

I hope I am wrong but there’s a non-zero chance that we have entered a year-long bear market during which the commonplace buy-and-hold approach will lead to a significant drawdown. Trading in a bear market requires a completely different approach than trading or investing in a bull market. It is not easy but it can still be very profitable if we are nimble and tactical.

In this episode of Momentum Monday, we go over some of the currently interesting trading/investing themes and how to play them: tankers, online education, online doctors, home office, protective equipment, etc.

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The Selloff Turns into Panic

Between October of 2007 and March 2009, the S&P 500 lost 50% of its value. The decline was called the Great Recession. 50% in 1.5 years seems like a lot but it pales compared to the velocity of the current selloff. The right word to describe it is unprecedented.  Only three weeks ago, SPY and QQQ were at all-time highs. Fast forward to today, the drawdowns are -25% for QQQ, 27% for SPY, and almost 35% for the small-cap index R2k. This is not like 2008. This is like 2008 compressed in less than a month. 

Financial markets tend to over-discount known threats and we are in the midst of panic and forced liquidations. I know things look bleak at the moment and many are thinking about the worst-case scenarios for equities, but I can assure you that this will pass and things will go back to normal. In the meantime, it is important to keep a sizable cash position because the opportunities that will come after this selloff will be generational. Even if the S&P 500 goes to 170, which would be a 50% decline from its all-time highs, it is not going to get there in a straight line. There will be monstrous rallies along the way.

As the fear subsides, people will realize that life continues, even if it is a bit different than what we are used to. This is when select stocks will start to stand out and attract capital. Just like big trends rose from the ashes after  9/11 and many companies went up 10x to 100x in the following years, the same will happen again. Even today, we saw online education platforms like LRN and CHGG stand tall in a red tape. If all education in the U.S. and possibly the world is moving online for the spring or longer, LRN and CHGG are likely to benefit. 

In relation to the coronavirus, the best we can do is make sure our immune system is prepared, so rest well, eat healthy food, exercise, add zinc and vitamin supplements to your diet. For the majority of people, this virus is not a threat. For the most endangered groups, we have to come up as a united and understanding society and try to limit everyone’s physical social contacts to prevent the spread. We don’t need the government to tell us that. This too will pass and life will go back to normal.