Under a picture like the one above, the internet headline asked, “Is this a bison or a buffalo?” Having once foolishly been driven in a Jeep in among a herd of the largest North American animal (with males averaging over a ton in weight), I had to read the answer.

I wasn’t surprised when the answer given was “It’s both.” Although technically a bison, the American version of the beast is often called a buffalo. This differs from the overseas species, which are usually labeled only one of the two names.

I have always been fascinated by the American buffalo. A picture of one of these magnificent animals on the plains defines the American West for me.

Reading of their near demise from herds estimated to have totaled 30–60 million in the 1500s to around 325 wild bison in 1884 is a sickening reminder of human excess. Still, the efforts of just a few people have preserved remnants of the great herds and brought the total back to over half a million animals (most of which are still in private hands) in the U.S. and Canada.

Bull and bear markets are like buffalo. We think we know them when we see them. Investors have tried to define them as moves of 20% in either direction in a financial index. But using such a standard really doesn’t capture their complexity.

Focusing on bear markets, a study of the Dow Jones Industrial Average since 1945 demonstrates that when the stock market declines, these downturns can be characterized more specifically. And, of course, based on the assets invested and an investor’s attitude toward risk, each category of a bear market can have a very different meaning to individual investors.

I love the following chart provided by Guggenheim Partners. It gives a historical perspective that seems to suggest there are at least two different types of bear markets instead of only one.

the deeper

I call the declines above the line “baby bears.” The decline is less than 20%. They are frequent. Just the 5%–10% variety has occurred 78 times since WWII. That’s at least once per year.

The “super bears” below the line are rarer. Only 11 have thundered down upon us in the last 75 years. On average, that’s just one about every seven years.

In addition to the magnitude of the fall and the frequency, there are other differences between the two types of bear markets. The length of the decline of a baby bear and the time it takes to recover from one are much less than those of a super bear.

With the ultimate super bear (the version with a 40%-plus decline), one may experience 22 months in decline and another 58 months to return to breakeven. That’s 80 months (almost seven years) with no growth at all. And, as the chart shows, they can occur more than once in an investor’s lifetime.

Finally, the green line that separates the baby bears from the super bear also suggests a strategy for investors. By including a diversified portfolio of asset classes as a part of one’s portfolio, investors can stay invested and reap the benefits of the rather short-lived and minor impacts of a baby bear.

But when a super bear enters the scene, investors need more. They need tactical strategies that can hedge, go to cash, and move into other defensive positions such as gold and bonds to mitigate the very large losses stock-only investors experience during such markets.

What this means is that investors need portfolios that are both diversified by asset class and strategy for the baby bears and also contain tactical strategies for the super bears if they are to avoid being buffaloed by the next bear market.

Market update

Stocks fell across the board last week, with declines in all of the stock market indexes. Gold (hitting a new 10-week high) and bonds (with a new six-month low in yields) gained ground.

For the venerable Dow Jones Industrial Average, last week marked the sixth declining week in a row. The Index has only fallen seven weeks in a row seven times since 1900, and eight weeks in a row only once.

So far, the decline has been very shallow. For the Dow, it has been one of the shallowest six-week declines on record.

With the S&P 500’s fall of 6% and the NASDAQ decline of 8% (after just hitting their all-time highs at the end of April), the bear market should be categorized as a newborn baby bear rather than as a true bear market. Yet the news commentary makes it sound like we’re in the grip of a super bear.

Part of the reason for that is no doubt because much of the market angst can be traced back to President Trump’s tweets on trade. Although, in fairness, the president was no doubt upset by the sudden Chinese repudiation of a draft agreement rumored to have been over 200 pages long and virtually ready for signature.

Of course, it did not help last week to have him throw another log on to the fire by bringing up tariffs on Mexico as well—and then throw gasoline on the blaze with the announcement of investigations of big tech.

I do think that the state of the market is such that concern is warranted. I just don’t believe we should go overboard.

Technically, the market looks a mess. As the following chart shows, we have basically gone nowhere for over a year. And we have now blown through both the 50-day and 200-day moving-average levels that often provide support. That does look like the fourth quarter all over again. At least a death cross (when the short-term moving average crosses below the long-term moving average) has not occurred this year.

s and p 500

Also promoting the concern are a number of fundamental factors. Earnings season is over, and it ended with fewer companies beating analyst earnings and revenues estimates than in the last quarter. Global economies have had weaker economic reports, and even here in the U.S., the IHS Markit Flash Purchasing Managers’ Index (an index of the current direction of economic trends in the manufacturing and service sectors) shocked with an early warning, as it came in at the lowest level in 10 years!

The ISM Manufacturing Report declined. Similarly, construction spending disappointed on the residential side of the market, a strange occurrence as 4% mortgages once again begin to appear.

Then again, there is that interest rate decline. This has caused the yield curve of the 10-year Treasury versus the three-month T-bill to invert for a second and third time this year. This, in turn, has increased the talk of a coming recession. It certainly supports the current betting on a rate cut in the near future.

Of course, at times like these when there is a strong smell of fear and negativity in the air, there are always the offsetting scents of positivity. For example, of the companies that have released earnings since reporting season concluded, more than 70% have beaten analysts’ estimates. Economic report surprises appear to have bottomed and are increasing. Furthermore, the number of favorable year-over-year economic reports is now positive for a second month after falling for seven straight months.

The price-earnings valuation ratio is now two points lower than it was last fall. The dividend yield of the S&P 500 is almost equal to the yield of the 10-year bond, leveling the playing field. And the risk-on/risk-off ratios appear to be on the oversold side.

On a sentiment basis, investors are extremely pessimistic. Bullish sentiment is down in the 24% area in the American Association of Individual Investors’ poll. Since this is a contrarian measure, historically, it is a bullish reading—as is the very low level of call volume compared to put volume on the Options Exchange.

Finally, on the plus side, seasonality measures are more bullish in the early summer than in the later months. This is especially the case following a 4% or greater down month in May.

Yet, I think there could be a bit more room to the downside. It’s like what they told me when I was in among the buffalo, “If the tail goes up, an attack is possible.” It was the case then, and it’s still the case with the markets today … I’m watching very closely.

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