By Mark Hulbert
The bear market for stocks isn’t over. In fact, it may have aways to go. That’s because — even with the S&P 500 /zigman2/quotes/210599714/realtime SPX +0.16% 16% below its all-time high, and both the Nasdaq Composite /zigman2/quotes/210598365/realtime COMP +1.75% and the Russell 2000 Index /zigman2/quotes/210598147/delayed RUT +0.79% into bear-market territory — many investors are more focused on when and where to invest in stocks than worried about the possibility of further, steep declines.
This bottom-fishing is more reminiscent of the “slope of hope” that bear markets typically descend than the “wall of worry” bull markets like to climb. That doesn’t mean the U.S. stock market couldn’t mount an impressive rally from current levels. If it does, it more likely would be a bear-market rally than the beginning of a new bull-market leg that takes the major market averages to new all-time highs.
A review of past bear markets suggests that, when the current bear market does hit bottom, few investors will even be contemplating that possibility. We either won’t even be paying attention, having grown so dejected as to have thrown in the towel, or will consider any sign of market strength as a bear market trap.
That’s not Wall Street’s current mood. Bear-market psychology follows a progression that is similar to what psychologists call the five stages of grief — denial, anger, bargaining, depression and acceptance. Here’s how they manifest in the stock market:
Denial — In this initial stage, the prevailing view is that stock-market weakness is nothing more than a buying opportunity. Far from getting angry (see next stage), investors remain quite sanguine, since the market’s pullback offers an opportunity to buy stocks more cheaply than would have been the case had the bull market kept going.
Anger — Denial becomes increasingly difficult to sustain as the market’s pullback becomes too severe. Investors’ mood eventually morphs into anger, as they rail against the unfairness of the pullback. A hallmark of this stage is where investors see the pullback as a personal affront — as if the market cares whether you or I lose money.
Bargaining — In this stage, investors’ redirect their energies to figuring out if they can maintain their lifestyles despite the hit to their portfolio; retirees rejigger their financial plans. Investors promise to give up that fancy new car or the European vacation — the fat from their budgets — so long as they don’t have to cut bone.
Depression — As the market continues to slide, the realization sets in that cutting the fat isn’t going to be enough. Major changes in lifestyle will be required. Near-retirees work for longer than originally planned; retirees go back to work.
Acceptance — In this final stage, investors throw in the towel. They surrender to the bear market and stop even fantasizing about when it might end. They treat any sign of market strength as a suckers’ rally, luring the gullible into losing more money on the next leg down.
Where we are now in this cycle
My impression is that we’re no further through this five-stage cycle than the second one. There are individual exceptions, of course, since not all investors progress at the same pace. But the preponderance of the attitudes I encounter are either that the pullback is a buying opportunity (stage one) or that the market’s weakness is profoundly unfair (stage two).
Investors’ progression through these stages must be genuine. As I noted last week , it’s not meaningful to say you’ve thrown in the towel, only to quickly jump on the bullish bandwagon at the first sign of market strength. Such a reaction is little more than stage-one behavior in disguise.
Which brings me to recent claims that we’re seeing signs of capitulation on Wall Street. If the capitulation were real, that would be evidence that we’re in stage five. But I’m skeptical: In a genuine capitulation, there is no eagerness to detect capitulation. Key hallmarks of genuine capitulation are apathy and indifference.
Not all declines go through all five stages, of course, just as not all corrections turn into major bear markets. So this discussion doesn’t mean the market still has a lot further to fall. But if the bulls want to claim the force of contrarian analysis to support their belief in a rally, there needs to be genuine capitulation. Otherwise, the bulls’ arguments are simply evidence that the market’s decline is in early innings.