Part II: What to Expect After a Bear Market Bottoms

May 13, 2009

We think the odds are decent that March 9 marked THE low for the bear market that has been clawing investors since December of 2007.  The powerful 37% rally since March 9 and the historic demand driving it, along with the “green shoots” of economic recovery spurring that demand, all suggest that we may have turned the corner.

Should that prove to be the case, it doesn’t mean we won’t experience further scary declines.  On the contrary, it suggests that we will.

Typically, after the market has made a major bear-market bottom you get a powerful rally and then an “echo” decline that retraces part of the rally–it’s a two-steps-forward-one-step-back kind of pattern.

If you were around and watching in 2002-2003 you’ll recall that the bottom of that bear market was made in October of 2002.  The market rallied off that October low, rising 24% into January of 2003 before rolling over and falling 17% through mid-March.  The March low was higher than the low made in October, but the fall was no fun nonetheless.

This is what happens most of the time after a major bear-market bottom has been put in place.  And it makes sense: In the earliest stage of a new bull market, skepticism is high.  The market rallies powerfully, gaining 20%-30% or more and lots of burned stock holders decide to take the money and run (i.e., sell).  This creates a wave of selling that swamps demand–temporarily.  With the last shares in weak hands shaken loose, the bull reasserts itself and prices move back up.

It’s possible this sort of sequence won’t unfold this time.  But we expect it will.  If it does, we’ll consider that an opportunity to increase our equity exposure.  Stay tuned.