Where are stocks headed? To answer this question, there are certainly many methods that are employed by investors, traders and analysts, such as fundamental analysis, technical analysis, economic indicators, and market sentiment. But what about logic?
I believe the line that intersects science, mathematics and philosophy is logic: Scientific theories, algebraic equations, and philosophical reasoning are all structured arguments and inferences to draw a conclusion based upon what we already know...
Using logic correctly, we will review data-points or factual information available to us, use them to form our logical assumptions, then make conclusions based upon our assumptions...
"Bad reasoning as well as good reasoning is possible; and this fact is the foundation of the practical side of logic." ~ Charles Sanders Peirce
Let's apply logic to draw some conclusions with regard to the projected depth and duration of the current bear market for stocks. Here's what we already know:
- Since 1926, the average bear market -- typically defined as a drop of 20% or more -- has lasted 1.3 years.
- As measured by Standard & Poor's 500-stock index, stocks have plummeted an average of 33.5% during those bear markets and that includes the three "once in a generation" declines: 1) The Great Depression-induced drop of 86%, from 1929 to 1932, 2)The 1973-74 decline of 47%, and 3) The "tech-wreck" fall of 44%, from 2000 to 2002.
- Since the 1930's, all but two bear markets have been significantly milder than average -- with losses generally averaging between 20% and 30%.
- The current bear market decline from the October 9, 2007 peak to the most recent low on July 15, 2008, is approximately 22% and the duration is just over 8 months.
Now for some logical conclusions supported by our data:
- This bear market is not a "once in a generation" decline: The most recent generational occurrence (2000 - 2002) ended only six years ago, which is much less than a "generation" ago. We may further logically deduce that a generational decline would follow a generational appreciation in stock prices, which most would agree that the 2002 - 2007 bull market was not a generational climb for stocks.
- This bear market decline will not be far from average: The generational declines of a few historical bear markets account for a great portion or weight of the average decline, which is why all but two bear markets have been milder than "average." For an average decline in this current bear market, stocks have approximately 10% more to fall from the most recent lows.
- This bear market duration will not be far from average: This conclusion is more of a stretch to make but it follows the logic of the previous two conclusions and, for the sake of observation, does provide perspective: Based on the average bear market duration, this current decline would end (and the next bull market would begin) around January 2009.
Of course, our logic here is not intended to be presented as fact or truth and it certainly is not the basis for prediction or investment decisions -- it is intended as perspective amidst perception -- as logical observations based upon what we already know -- not upon what we do not know.
"The emotions aren't always immediately subject to reason, but they are always immediately subject to action." ~ William James
The perspective, based upon our logic, is that the worst of the bear market may be behind us -- not ahead of us, as our perception would have us believe. As emotions become more extreme, stock movements reflect those extremes in the form of market volatility, which always punctuate the latter stages of a bear market. Fear and panic manifest much quicker than that of complacency and greed.
"It is the mark of an educated mind to rest satisfied with the degree of precision which the nature of the subject admits and not to seek exactness where only an approximation is possible." ~ Aristotle
What we do not know is that our logical conclusions will become a reality, for this assumption would be illogical, especially when emotion and perception are factors. For this reason, I have argued that scientific methods cannot consistently forecast stock prices accurately because it is illogical, if not impossible, to quantify something that is influenced by emotion. Risk is quantifiable but emotions and uncertainty are not...
Emotion cannot be measured -- just as love cannot be explained by reason or logic, which is why the prudent investor's methods and strategies will fall short of prediction and market timing, in the absolute sense, and will reflect contentment in the absence of precision and "exactness where only an approximation is possible..."
Source: Kiplinger.com, Make Money in a Bear Market, Dec. 4, 2007