The Fiscal Cliff and Severe Real S&P500 Bear Markets – January 2013 Update

With the US Government this week deciding that it was going to make no attempt to at least start the country along the road towards living within its means, the so called Fiscal Cliff was avoided.  In response the S&P500 rose 4.0% in the week to close at 1,466.  While the main stream media were getting all excited about this increase I started to think about how this continual kicking of the can down the road could actually be storing up future problems, which might actually prolong the Severe Real S&P500 Bear Market I believe we may still find ourselves within.  I last posted about this analysis in September 2012.  As a reminder I define a Severe S&P500 Bear Market as a period in time where from the stock market reaching a new Real (inflation adjusted) high it then proceeded to lose in excess of 60% of its real Value.

The previous Severe Real S&P500 Bear Markets are revealed in the chart below which corrects historic S&P500 Prices since 1881 by the devaluation of the US Dollar to arrive at Real Prices.  This chart shows we are now back to Prices last seen in March 1998 and also shows we have seen three previous Severe Real Bear Markets.    

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If I think of the US Government putting off this unpopular decision for another day then at some time in the future the bond market may force them to make a decision.  Of course at that time they will then have somebody else to blame which will suit the weak politicians whose only focus seems to be to get themselves re-elected.  The subsequent rise in taxes and cuts to spending which would then follow would then have to be worse than they were faced with today because through indecision they have made the problem a larger one to solve. The S&P 500 may then respond with a big fall which brings me back to the chart above.  Now there is of course a risk that I’ve been looking at this chart too long however I can generally see in the last 3 Severe Bear Markets two lower Real highs following the initial new Real high.  From this second lower Real high we then see Real Prices fall between 40 and 60%.  Are we are nearing that second lower high and could this government indecision actually end up causing this next big leg down?  Of course I would never buy or sell based on this hypothesis because the market can remain irrational far longer than I can remain solvent.

If I overlay the three Severe S&P Bear Markets with today’s market by comparing the percentage change in value from the peak for each of these periods we arrive at today’s second chart.  So what were these previous bear markets?

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