The bear has retreated, but are we out of the woods?

Investors might be surprised to learn that we're meant to be in a bull market, writes Proinsias O'Mahony

THE BEAR is dead, long live the bull. Investors looking at their bloodied portfolio might be surprised to learn that we're meant to be in a bull market. With the SP 500 advancing by more than 20 per cent since bottoming in November, the most common technical definition of a bull market has been satisfied.

Whether the bear is dead or merely in hibernation is a moot point, however. Not all analysts agree on what constitutes a bull market. Some say a true bull needs to hold on to its gains for a certain period of time, and a 20 per cent spurt in 11 trading sessions should be treated with extreme caution.

Even without using strict criteria, it is plain to see that global markets remain in both a long-term and intermediate-term downtrend. Not only is the SP 500 almost 20 per cent below its 200-day moving average, but it also sits below its average price over the last 50 days. In fact, just 26 per cent of US stocks are perched above their 50-day averages, indicating that most stocks remain mired in obvious downtrends.

Bears can argue that the recent upswing is the product of the extraordinary volatility that has gripped stock markets. Despite the swift run-up, US markets are trading at levels seen just a month ago. In fact, the SP 500 is well below its November high.

Commenting on the unprecedented volatility, a recent Citigroup report noted that the SP 500 moved more than 5 per cent in a single day on just 27 occasions between 1950 and 2000. Between October 1st and December 2nd last, it occurred on 22 occasions.

The SP 500, long regarded as the most liquid and efficient index on the planet, is exhibiting movements ordinarily associated with emerging and speculative markets.

Merrill Lynch economist and long-term bear David Rosenberg questions whether the market can build on its recent gains.

Rosenberg points out that markets have seen eight bear market rallies since October 2007, ranging in strength from 8 per cent to 24 per cent, with each one being "enthusiastically" greeted as a long-term bottom.

The rallies, Rosenberg says, are "getting shorter and more flashy" but "they are still bear market rallies", mere bounces "that investors should be using as an opportunity to sell into".

Historical analysis gives succour to both bears and bulls. Since 1940, rallies of 20 per cent have almost invariably led to indisputable bull markets, only failing to advance further on one occasion. Unfortunately, that was during the most recent bear market, with markets rallying strongly soon after the 9/11 attacks only to eventually sink much lower.

Not only that, the current bear is the most severe since the Great Depression of the 1930s. The bigger the bear, the bigger the bear market rallies: between 1929 and 1932, US markets saw no fewer than four 20 per cent rallies.

Ironically, the ostensibly commonsense argument that markets will inevitably give up their gains due to negative news flow in the coming months is not supported by historical analysis.

Global recession, mounting corporate defaults and rising unemployment may dominate the headlines in 2009, but markets frequently advance in the face of adversity.

At the height of the market meltdown in mid-October, Warren Buffett called on investors to put their money to work on the grounds that "bad news is an investor's best friend".

During the Great Depression, Buffett pointed out, markets bottomed in July 1932, even though the economy continued to deteriorate until Franklin D Roosevelt came to power in March 1933. During the second World War, Buffett noted, markets bottomed in April 1942, "well before Allied fortunes turned". In the early 1980s, "the time to buy stocks was when inflation raged and the economy was in the tank", he added.

Market reaction to last week's horrific jobs report in the US bears out Buffett's point. A total of 533,000 jobs were lost in November. The worst monthly job losses in 34 years, the figures surpassed even the most pessimistic estimates and catalysed apocalyptic comment from analysts and economists alike. After selling off in early trading, however, the bulls came out in force and the market closed 3.7 per cent higher.

Those gains have been consolidated this week, leading many to conclude that markets have already priced in a deep and protracted recession.

Still, whether November's low marks "a" bottom or "the" bottom remains open to question.

Legendary value investor and Buffett mentor Benjamin Graham famously characterised "Mr Market" as an irrational animal whose moods swing from intoxication to despondency and back. The fluctuations have been particularly vicious and swift of late, setting investor pulses racing.

Continued uncertainty means few traders will be unfastening their seatbelts any time soon.