Don’t Worry: Bear Markets Are a GOOD Thing

John DVIt always amazes me how after a small decline in the stock market, pundits from all over come out of the woodwork to determine if this is the bottom. It’s been a while, but bear markets do happen!

Bear markets are a good thing. They clean out the excess. It’s sort of like a forest fire that clears out the brush and paves the way for new growth. Everything works in cycles.

Unfortunately, the longer the current bull market remains intact, the more pain will be felt on the downside once the trend changes. Last week I discussed how volatility and a crisis in confidence in the Federal Reserve has signaled that the trend may have already changed.

Other factors confirm my thinking. They include insider buying and investor sentiment. On Monday, Charles Sizemore talked about why this doesn’t look like a bottom based on insider buying trends. Insiders tend to be pretty good at spotting major bottoms and scooping up their shares at bargain prices.

But let’s take a closer look and narrow down the timeframe a bit. Thus far in September, as the market has yo-yoed all over the place, insiders have bought less than $600 million in stock.

But, more striking is that almost 40% of that buying volume has happened in just one company – Seattle Genetics.

Management has also taken its finger off the buy button, and corporate buybacks are slowing below trend. While the month is not over yet, the total may be as much as 20% below average for 2015.

This is hardly an endorsement for the market’s prospects.

Coinciding with insiders’ nervousness is the public’s enthusiasm for stocks.

U.S. equity ETFs have attracted $8.5 billion – that’s a lot of money going into stocks considering the pullback we’ve had recently. These are mostly individual investors trying to call a bottom, and as a whole this group is terrible at calling bottoms.

By the same token, U.S. mutual funds have seen redemptions of $10.5 billion. Money goes out of mutual funds when investors are more bullish toward stocks. And while the markets are down sharply for the month, this represents the smallest withdrawal in over six months.

More bottom calling and more bullishness. But we don’t want to run with the herd. This is a contrary indicator we want to move against. Individuals as a whole are rarely right.

Meanwhile, investors overseas have pumped money into Europe and Japan despite steep losses in those markets as well. It’s the same thing. Investors are calling a bottom, which makes it more likely that it is in fact not.

The actions of insiders and investor sentiment indicate to me that it is still too risky to allocate large blocks of capital to equity markets. We need real selling and blood in the streets before a great buying opportunity will again present itself.

John Signature

John Del Vecchio
Editor, Forensic Investor

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Categories: Cycles

About Author

In 2007, John Del Vecchio managed a short only portfolio for Ranger Alternatives, L.P. which was later converted into the AdvisorShares Ranger Equity Bear ETF in 2011. Mr. Del Vecchio also launched an earnings quality index used for the Forensic Accounting ETF. He is the co-author of What's Behind the Numbers? A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio. Previously, he worked for renowned forensic accountant Dr. Howard Schilit, as well as short seller David Tice.