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The Next Bear Market Will Be Ruthless

Summary

It has been almost nine years since the outbreak of the financial crisis. And it has been more than seven years since the start of the most recent bull market.

The Fed has created a bubble not only in asset prices but also in the investor belief that the value of their investments will be protected no matter what.

Unfortunately, the next bear market will eventually come, and it is likely to be ruthless once it finally arrives.

Investors who recognize such an eventual reality can stand at the ready to capitalize once the time finally arrives.

It has been almost nine years since the outbreak of the financial crisis. And it has been more than seven years since the start of the most recent bull market. Stocks have been impressively resilient in the face of every test during the post-crisis period thanks in large part to the seemingly endless support from monetary policymakers including the U.S. Federal Reserve. This has helped foster an environment where many investors are not only comfortable but have swagger about owning stocks at historically high valuations despite chronically slow growth. As a result, the Fed has helped create bubbles not only in asset prices but investor expectations that the principal value of their investments will be upheld no matter what challenges befall the economy. Unfortunately, just like the bursting of the tech bubble and the onset of the financial crisis, the next recession will finally come. And when it does, it has the potential to be absolutely ruthless for investors.

Let's Get This Out Of The Way

I can already hear the bulls sharpening their knives for the comment section of this article, and I very much look forward to reading and responding to all points of view including those that strongly disagree with my article, but let me get out in front with a few observations.

Indeed, I have been bearish for some time, but this does not mean that I'm predicting that everything is going to go up in smoke tomorrow. Just as the tech bubble went about four years longer than it probably should have, the same could definitely be said for today's market. Moreover, we could see the S&P 500 Index (NYSEARCA:SPY) continue to rally for the next several months or couple of years. Then again, we could already be one year into a new bear market. Only time will tell. But what's important to note is that the higher and longer today's market continues to rise, the longer and harder it is likely to fall on the backside. In the meantime and until we start to definitely roll down the other side of the mountain, I have and will continue to hold a meaningful allocation to stocks.

But isn't my holding stocks a contradiction to my bearish view? Absolutely not. For just as being bullish does not mean that one should be all in and 100% allocated to equities, being bearish does not imply that one should be completely out of stocks and hide away in a bunker waiting for the world to end. Bear markets slowly evolve over long-term periods of time, and selected segments of the stock market have historically demonstrated the ability to perform well during different stages of bear market cycles. For example, consumer staples (NYSEARCA:XLP), utilities (NYSEARCA:XLU) and healthcare (NYSEARCA:XLV) stocks all typically perform well during the early stages of a bear market, and selected specific stocks of various styles and sizes such as Wal-Mart (NYSE:WMT), Village Super Market (NASDAQ:VLGEA), Community Bank System (NYSE:CBU) and Southern Company (NYSE:SO) have demonstrated the ability to perform well throughout the entirety of two of the worst bear markets in history in the bursting of the tech bubble and the financial crisis. So while I may not be loaded up on the SPY, the market offers a solid menu of stocks that one can hold through the worst of a market storm. I also own a lot of other things outside of stocks that are performing well today and I expect will perform even better during any future bear market in stocks.

Also, isn't my making a statement that the next bear market could be "absolutely ruthless" for investors nothing more than fear mongering? No, it is not. Instead, it is trying to increase investor awareness of a view that they may not otherwise be hearing. After all, one only has to tune into one of the major financial news networks to hear a cornucopia of bullish views on the market, many from analysts that have a direct vested interest in promoting such bullish views and reassuring the audience that despite any short-term rough patch that "stocks will be trading higher by the end of the year." Conversely, those expressing a bearish view are often met with heavy pushback and scowling derision. As a result, this leaves many that may be less experienced with investment markets exposed to the risk of wondering "why didn't I see this coming" when they eventually find themselves locked in the jaws of the next bear market.

In the end, it is up to individual investors to decide how they wish to proceed with their own portfolio allocation. But by sharing this more bearish perspective on today's markets - it at a minimum provides investors with a viewpoint to consider that they may not be hearing elsewhere.

Now that we've got that out of the way, let's get down to it.

The Economic/Market Disconnect

The next bear market is setting up to be ruthless for investors. But this does not mean that it will be ruthless for the U.S. economy. In fact, it would not be surprising at all to see a prolonged and significant decline in stocks accompanied by what amounts to a somewhat longer than normal but otherwise relatively mild economic recession. How can this be the case? Simple. Since Main Street (NYSE:MAIN) hardly participated in the glorious ascent that has been Wall Street via the stock market over the past seven plus years, Main Street is not likely to suffer nearly as much when stock prices come falling back to earth. In fact, many parts of Main Street might actually find themselves benefiting in many ways including even lower interest rates on loans, lower gasoline prices at the pump and the execution of more effective fiscal programs by policymakers that finally have had a long overdue fire lit under them.

Impossible, you might say. How can we have a major stock market decline with a relatively milder impact on the broader economy? One has to look no further than the bursting of the technology bubble from 2000 to 2002. During this time period, stocks declined by more than -50%, but the economy hardly even declined. Although we...


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