The big bear strikes—now what?

“Things are different this time. Markets can continue to go up, despite stock valuations that have no rational relation to corporate earnings.” That’s what some of the experts were saying early in 2000. By now it is hard to find anyone who has not had those notions pounded out of them by what almost became the second-worst bear market of this century. Only the great crash of 1929 and the subsequent four-year bear market was worse than the grinding, 2½-year-plus bear that we have suffered through.

It is hard to minimize the decline in U.S. stocks from January 2000 through late July 2002. The Standard & Poor’s 500 Index fell a cumulative 44% during that period, almost as much as the market fell during the 1973-74 bear, which, until now, has been the worst bear market since World War II. Many investors are suffering even worse declines because they were invested in the once popular technology sector. The NASDAQ 100 Index, which includes many of technology growth stocks, fell over 78% since this bear market began.

What happens next? The markets have always recovered from declines in the past, but is this one different? Will this century start out by experiencing the second Great Depression? The answers: we don’t know, it’s not different this time, and we don’t know. Forecasting the short-term future of the stock market and the economy is impossible. No one can tell you exactly what will happen over the next six, 12, and 18 months.

Plenty of commentators will try anyway—you’ll hear predictions for further declines, a long or short recovery, or a big rally. Remember that these commentators are the same ones who a littler earlier this year were calling for a market recovery any day now. A few years ago they speculated on how many weeks or months it would take the NASDAQ to top 6,000 (looks like it may be a long time now).

The most confident prediction an investor can make is that things won’t be different this time. At some point the bear market will end and the stock market will climb. Often, the ends of big bear markets are ugly and it usually appears that a turnaround is still far off. Observers will shrug off any jump in stock prices. They will dub it a bear market rally and argue that the long-term trend is still down.

It is reasonable to see prices come down to earth from the peaks they occupied in early 2000. But big bear markets like this one usually overshoot any reasonable downward adjustment. Prices usually don’t adjust to a “reasonable” relation with corporate earnings. Instead, investor fears drive prices much lower, sometimes to the point of being screaming bargains. At that point, many investors will have left the market, selling off and realizing big losses. The few who remain will enjoy recovery rallies that can be substantial, such as the 54% gain in 1935, the 44% gain in 1958 and the 37% gain in 1975.