"Bye, bye, bears," said the wonderfully flamboyant Jim Cramer on his Mad Money T.V. show this week on July 30. "I'm sticking my neck out and calling the bottom," he said, mainly because he thinks that negativity in the market is striking. We applaud his willingness to take a bold stand – particularly since we know from experience that it takes fortitude to call tops and bottoms. But we think it might be just a bit early. After all, it's not even obvious that people have given up on the stock market. In fact, his hopeful sentiment is exactly what bear markets bring out in investors – the hope that things will turn around just after the next market dip. This is analogous to investors worrying at the beginning of a bull market, a behavior that famously has been shortened into the adage, "bull markets climb a Wall of Worry." In contrast, Bob Prechter calls the bear-market behavior "sliding down a Slope of Hope." Read more about how you can really tell what a bear market looks like in this excerpt from Prechter's Perspective, where Bob Prechter answers questions from the media.
Q: What are some characteristics of a major market bottom?
Bob Prechter: General despair. Investors completely give up. Sometimes you even begin to hear arguments as to why that market really has no reason to exist. For instance, in 1932, people said capitalism was dead, stocks were dead, and they'd never go up again. We had that situation in gold in 1971, when the government decontrolled it. Several economists came out and said that as soon as they took off the price controls at $35 an ounce, gold would drop to $6 an ounce because it had no industrial utility.
Q: The market is an amazing beast. It even manages to do damage on the way up. Richard Russell has said that the "diabolical objective of bull markets is to advance as far as possible without any people getting in." The opposite is apparently true in bear markets.
Bob Prechter: Exactly. It's the old story. Bull markets climb a Wall of Worry. I made up a parallel maxim: bear markets slide down a Slope of Hope.
Q: In the mid-1980s, you anticipated this idea in the great bull market when it was just getting under way. You said, "Somehow the Dow has to get to 3600-plus with almost nobody aboard.
Bob Prechter: All I really meant was that for the mechanism of the market to be satisfied, there must be reasons for people to disregard really important advice at the time it is most important that they actually take it. The psychology of 1984-85 was exquisitely instructive in this regard. Advisors, newspapers and brokers hated the markets. They were amazingly bearish. So the market went up with the fewest possible people participating. In fact, they were shorting and losing money as it rose. The history of markets shows that over 90% of investors cannot make money in the market. The few successful ones you occasionally hear about usually took the approach of long-term buy-and-hold, without regard to trend, and they were lucky enough to be in a multi-year bull market.
Q: What about so-called typical investors?
Bob Prechter: So-called typical investors just don't make money for long. They get interested in the markets at the top of every bull trend, and they get scared out at bottoms. The short-term traders lose even faster. They're sending 2% or 3% of their accounts to the brokerage industry in commissions every week or so. How long can you survive that without a good rate of market success? Since people's hopes and fears are the engine of the market – their hopes make it go up and their fears make it go down – the result is that most people must lose money. It is their fears that make them sell near bottoms and their hopes that make them buy near tops.
Q: Let's say you could dissect the average investor's stock portfolio over the course of a full cycle. What would it reveal?
Bob Prechter: More than 75 years ago, Don Guyon, the pseudonymous author of One Way Pockets, wanted to discover why his clients always lost money in a complete bull-bear cycle. It might be argued, he reasoned, that, at worst, they should have broken even, since at the end, prices were back to where they were at the start. He found that the answer lay in the clients' temporal orientation to the market's future. At the beginning of a bull market, he found all his clients were traders. At the top, they were all "investors." This is not only precisely the opposite of the correct orientation for making money, but also entirely natural for human beings and a key reason why the market repeatedly behaves as it does.
Q: Why do you say we are experiencing a long-term top of historic proportion?
Bob Prechter: Partly the pervasive market psychology of buying and holding stocks. "Focus on the long term and hold your stocks" is what people said right after major peaks in the 1930, 1946, 1969 and 1973, too. Back, in 1974, 1978, 1979 and 1982, you almost never heard that kind of commentary. The public certainly had no truck with it. Today, it's everywhere. People are writing books about how if you just buy stocks and hold them, you'll get rich. I think that's an excellent description of the past, but I don't think it's going to describe the next 10 years at all.
Q: When will we know for certain that we have seen a market top?
Bob Prechter: For certain? When it's too late to act!
Q: If you don't know until it's too late, should traders try to pick tops?
Bob Prechter: By all means, yes. Waiting for certainty means waiting long enough to miss it.
Q: At what point in the Dow would a crash scenario become a possibility?
Bob Prechter: Any time it's open.