How a Bear Market Works

‘The euro rose against the majority of its most-traded counterparts after French President Nicolas Sarkozy and German Chancellor Angela Merkel said Greece should remain in the union, damping concerns of turmoil in the region.’ – Bloomberg

— We guess that settles it then. If Nicky and Ange say Greece should remain in the union, then Greece shall remain.

— But saying so doesn’t make it so.

— The tug-or-war between the market and the bureaucrats is really heating up. The market – the collective wisdom (or otherwise) of everyone managing their wealth in their own self-interest – is saying unequivocally that Greece will default.

— The evidence? One-year bond yields are a juicy 140 per cent. The two-year bond yield is 74 per cent while the 10-year yield is over 25 per cent. The private sector long ago gave up believing Greece’s credit was good. But the moves in these yields over the past few weeks are the markets’ way of saying the game is up for Greece

— Then you have the bureaucrats. If ‘the market’ is a collection of individuals acting in their own self-interest, the bureaucrats of Europe base their actions on a type of collective interest. If Greece defaults and it’s not well-managed or organised, it will set off a chain-reaction that will stop the euro gravy train in its tracks.

— This won’t be beneficial for those currently strolling along Europe’s halls of power. Greece might appear very determined to remain in the Eurozone but that’s more a reflection of the Greek politicians’ desire to maintain the status quo. That is, what’s best for them and their mates rather than Greek society as a whole.

— Why else do you think they just announced a new €2 billion property tax? It’s a desperate measure designed to get the next tranche of IMF money at the end of the month. There’s little chance they’ll collect it all of course. But at this stage it’s all a game of keeping up appearances.

— While researching the euro farce this week for our Sound Money. Sound Investments report, we came across the following quote from our old mate Frederic Bastiat:

‘When plunder becomes a way of life for a group of men living together in society, they create for themselves in the course of time, a legal system that authorizes it and a moral code that glorifies it.’

— And this one from Mayer Amschel Bauer Rothschild:

‘The few who understand the system, will either be so interested from it’s profits or so dependent on it’s favors, that there will be no opposition from that class.’

— So nothing has really changed in finance over the past few hundred years. The corruption has just gone global. While a financial market illiterate can see that Greece is headed towards bankruptcy – and there is something very wrong with the whole system – those ‘dependent on its favours’ are resisting reality.

— When it comes to believing the platitudes of self-interested politicians or the cold judgement of the market, we’d take the market’s view any day.

— Why does this matter for the Aussie investor? After all, we’ve heard plenty of times (from self-interested market cheerleaders) that ‘Greece is a tiny economy and what goes on there shouldn’t impact…’ and blah blah blah.

— Greece is simply a representation – a shining example – of the corruption and bastardisation that capitalism has undergone over the past 40 years. And at the heart of this corruption is having a monetary foundation of unsound money.

— Such a system bestows favours on those who don’t earn or deserve it. It extracts wealth unfairly from those who strive to create it. In short, it retards the risk-and-reward mechanism that is the foundation of dynamic capitalism.

— So in the true sense of the word, it’s retarded.

— And when you have a retarded monetary system that has gone beyond the point of no return (that point was reached in 2007) wealth destruction follows. The moniker we apply to a period of wealth destruction is ‘bear market’. That’s what we are in now, dear reader. And this one could be epic.

— What makes a bear market epic is continual interference of the market mechanism. Because the world is cursed with weak and economically ignorant leaders, continual interference of the market mechanism is what we’ll get, all in the name of trying to ‘do something’ to fix the problem.

— Such behaviour and policies usually end up taking from the most productive part of the economy and giving to the least productive. From an investors’ perspective, company valuations fall. So even though stocks look cheap (how many times over the past 12 months have you heard someone say the market is cheap?) it is simply prices moving ahead of valuations.

— Yep, in a bull market stock prices move ahead in anticipation of increases in value. In a bear market, company values fall because they become less profitable. The market anticipates this and prices move lower, giving the impression stocks are ‘cheap’.

— Occasional strong rallies lure buyers back in and fire up the industry propaganda machine, only to correct lower again and inflict more pain.

— We might be on the cusp of one of these rallies now. But always keep in mind – this is how a bear market works.

Greg Canavan
for Markets and Money

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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2 Comments on "How a Bear Market Works"

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Alexander Malejew

I read somewhere that a lot of people put their ‘super’ into cash at the bottom of a crash/correction and go long stocks at the top of the cycle!
This further amplifies the effects of a boom/bust cycle and surely destroys wealth!
Nothing wrong with gold/silver. You’d think it was illegal to own the stuff by the way people react.

For the Kevin Costner within you and along the lines of entrepenearial investments and stores of wealth (perhaps coinvesting with the Bill Bonner’s of this world …) The following item appears in the current edition of World Wide Words, the e-zine of lexicographer Michael Quinion Turns of Phrase: Seasteading There’s a famous quip attributed to Mark Twain; he advised readers to buy land because they weren’t making it any more. Since two- thirds of our planet is ocean, there’s still a lot of real estate out there, though admittedly rather damp and often inclement. The idea behind seasteading is to… Read more »
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