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The Bear Who Couldn't Swim

John Price, Ph.D.

Investment articles constantly refer to bull markets and bear markets with headlines such as "The Great Bull Market 1982-2000" or "No Bull: It's a Bull Market" or "Which Way to Go After a Bear Market" or "Surviving the Bear Market".

What do these terms mean? Bulls toss things up with their horns so rising markets are called bull markets. A more precise definition is that a bull market is a period when one of the major indices has increased by at least 20%. When this happens, we are said to be in a bull market.

In the opposite direction, bears tear things down with their claws so falling markets are called bear markets. As for bear markets, the more precise definition is when one of the major indices has fallen by 20% or more.

One of the most important indices in the US is the Standard and Poor 500. From its peak in March 2000, the S&P 500 has fallen by about 41 per cent. At one stage in mid-July, it was down by 48 per cent from its peak, the largest fall since the 1930s.

Over the same period, the London market has fallen by 34 per cent, Canada's market by 31 per cent and Tokyo's by 45 per cent.

These are definitely bear markets.

The Wall Street Bull

What about Australia? Over the same period that Wall Street has fallen by 41 per cent and all those other markets have fallen by roughly similar amounts, the Ozzie market as measured by the ASX 200 index fell by just 3 per cent. Since the end of April, the ASX 200 index has fallen just 9 percent, about half the decline in the US. 

You may be tempted to think that the Australian economy is independent of the rest of the world, or that it is simply more robust.

The real answer has more to do with the different composition of the indices. A very large proportion of the Australian market consists of financial stocks (around 44  percent), a strongly performing sector. It is also has a negligible weight in the poorly performing technology sector. 

The authors of the August "Statement on Monetary Policy" put out by the Reserve Bank of Australia recalculated the indices by reweighting the sectors to match those of the US. When this was done, the index showed a drop of 32 percent, much the same as the overseas indices.

For example, the Information Technology sector dropped by 91 percent in Australia and by 77 percent in the US. But in Australia this sector makes up less than 1 percent of the index whereas in the US it makes up 14 percent. 

So there it is. The Ozzie market when measured by standard indices had a very minor drop compared to the US and other major markets. This is why the US and European bears didn't make it to Australia. But on a sector by sector basis our drops are quite similar to those of the US. 

Despite the sector by sector similarities, some fear that the modest drop we have seen is just the start and that there is much worse to come. The Reserve Bank also considered this. They calculated that the average price-earnings ratio has risen since late 2001 from around 20 to 27. If this was the end of the story then it would be a definite worry.

However, a major part of this rise was due to the large losses incurred by News Corporation. When this company is excluded, the average P/E ratio comes out as 18. This is higher than the long term average of around 16, but not by much. And it lower than the average level of 32 for the S&P 500. By the way, last year the average P/E ratio for the S&P 500 was an astronomical 47.

What does this mean for us as investors? For a start, great companies are great companies no matter what the rest of the market is doing. And there are probably no more and no less great companies in a bull market than in a bear market.

The difference is that in a bear market you are more likely to be able to purchase these great companies at attractive prices than in bull markets. But the method doesn't change. Do as Warren Buffett does. Take your time to buy the stocks you want at the price you are willing to pay.

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