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Bear market

I believe the overall trend of the stock market turned down well before the Gulf crisis erupted. Fundamentally, stock prices reflect the prospects for corporate earnings, and given the economic circumstances I listed above, it's hard to be optimistic about the near term outlook for most companies. Once a bear market truly takes hold, it begins to feed on itself: headlines about plunging markets impair confidence, spending falls, sales reflect this, profits erode or turn into losses, dividends are cut, capital spending plans are scaled back, etc., etc., until the whole process ends in a downside spasm of despair and exhaustion, forming the base for the next advance.

Bear markets typically play out in three phases. In the first phase, stocks drift lower for no apparent reason. Most investors believe the sell-off is a normal consolidation before a further advance. In the second phase, stocks are falling for obvious reasons--companies are reporting lower earnings or losses, and many are skipping or reducing their dividends. In the final phase, stocks fall because people are dumping them to raise cash. Nobody wants to own stocks any more. This period of panic liquidation and exhaustion sets the stage for the next bull market (which occurs in three complementary phases). Today we're moving from the first to the second phase of this bear market. There isn't anything like enough fear around for this to be the final days of a bear market. In the recommendations section I'll discuss specific targets we can use as benchmarks for making stock-related decisions in this market.

Editor: John Walker