"Histories make men wise; poets, witty; mathematics, subtile; natural philosophy, deep; moral, grave; logic and rhetoric, able to contend." ~ Francis Bacon
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..."
Related Posts:
Uncertainty, Volatility & the 'Vix'
Source: Kiplinger.com, Make Money in a Bear Market, Dec. 4, 2007
The Beginning of the End (and of Brilliance)
It's time for a bit of perspective...
The chaos of the week will have most people intensely focusing on events as they occur without considering how their decisions, or lack thereof, will impact their future. As we think of and feel the challenges of the present, we essentially hold ourselves in the past, and we prevent ourselves from moving forward; we focus on what negative results could occur rather than how we may benefit; and we feel things that are not within our control as we lose sight of those things that are within our control.
Prudent risk management would have us investing long-term assets with a holding period of at least three years. Ask yourself if you believe stocks are more likely to be higher in three years or if they may be lower. If you haven't guessed, I'm firmly anticipating the former.
It is interesting to note that this week's stock price declines erased about three years of stock price gains. The lesson implied here is that, when the market is strong and the bull market duration is reaching average length, an assumption that stock prices will be higher in three years is not prudent risk management. Conversely, an assumption in today's bear market that stock prices will be lower in three years is not prudent either...
"Only in quiet waters things mirror themselves undistorted. Only in a quiet mind is adequate perception of the world." ~ Hans Margolius
It is difficult to step outside of the noise and simply observe. Let's take a quiet moment to make some observations about this week's turmoil for some perspective and, more importantly, to learn lessons for our future utility and growth:
This week may not mark the bottom for stock prices but it is showing signs of the beginning of the end --the beginning of brilliance for the prudent investor: Chaos brings order; storms and earthquakes destroy the weakest of structures and bring the construction of stronger ones; fires bring new life; nothing comes from something; something comes from nothing; and death gives sustenance and meaning to life.
Related Posts:
Weekend Wisdom: Uncertainty, Volatility and 'The Vix'
Investing in 'The Movement of Things'
Weekend Wisdom with Mohnish Pabrai
Bear Market Logic
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