A Bear Market My Dear Watson

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Dr. Watson: "You speak of danger.  You have evidently seen more in these rooms than was visible to me."

Sherlock Holmes: "No, but I fancy that I may have deduced a little more.  I imagine that you saw all that I did."

 

I have read many articles about the stock market collapse of 2008, and how anyone with a brain could have seen the crash coming.  The unfortunate takeaway from such a statement is that no one has a brain.  Very few actually saw that crash coming.  Oh, many people claim to have seen it coming.  But if they truly had, I imagine they would now be billionaires from shorting stocks, and buying put options.  The rest of us went over the cliff like a herd of buffalo following each other to a 7,000 point Dow drop.

But on the other hand, perhaps we all did see it coming.  All the signs were there.  We knew that credit was out of control, and the housing market, gas prices...Perhaps we just didn't draw the correct conclusions from the available evidence.

I thoroughly enjoy Sir Arthur Conan Doyle's Sherlock Holmes character.  I like the movies, but I'm referring specifically to the books.  It is always comical to hear him talk things over with his beloved Dr. Watson.  Both he and Holmes see the same things.  But only Holmes correctly deduces what the answer to the mystery is.  At first Holmes' conclusions seem ridiculous, until you see the logical processes he goes through to be able to arrive at said conclusions.  

Is there evidence before us right now we need to consider?  Could it be that we are heading for a bear market in 2013?  I believe we are indeed headed for a bear market, and I would like to present you with six pieces of evidence that have led me to my deduction my dear Watson:

1.  The Bull Market has had a Good Run

I only want to make one point here.  The stock market goes through cycles.  Every up is followed by a down. Every ebb has a flow.  We have had unprecedented returns in the stock market since January 2009.  This bull market has had a very good run, but logic says its days are numbered.  We don't know how much time this bull market has left.  We only know a bear market is inevitable.

2.  Food Prices are Rising

Food prices have been rising all year due to the terrible drought that adversely affected the majority of the United States earlier this year.  The higher food prices, especially beef and poultry, are due in part to higher feed prices. Tyson (NYSE: TSN) and Smithfield Foods (NYSE: SFD) are both good examples of companies doing fine in sales but bad in profits because of this.

<img src="http://media.ycharts.com/charts/759c5f24c93571f0fc7b88aa1fdeab79.png" />

TSN Profit Margin Quarterly data by YCharts

Food inflation is expected to continue another 4% before the end of this year.  But 2013 is not expected to be good for food prices either.  Beef is expected to rise 5% next year.

Food prices effect consumers, cutting into the money they could be spending on discretionary things.  But don't forget about the farmers.  High feed prices cut into their profits as well, leaving less money to spend on, for example, upgrades in their equipment.  When farmers hurt, the people who keep them going, like Deere (NYSE: DE), are also affected.  While we haven't seen farming equipment sales down significantly yet, it could be around the corner as food prices continue to rise.  The outcome of the harvest will determine what will happen for farm equipment manufacturers.  Some supply stores are reporting weaker sales already.  Deere, perhaps in caution, has also lowered their FY 2012 guidance.

3.  The Debt Ceiling Problem is Back

Yes, the debt ceiling is going to become a problem once again.  You haven't heard much about it because all the attention has turned to the presidential election.  Meanwhile the debt ceiling problem keeps just strolling along getting closer and closer to the edge of disaster.  Estimates say we will reach our current borrowing limit by late December.  Emergency maneuvers will keep us going until early next year.

This issue will likely be debated back and forth for a repeat of 2010.  If it is drug out, the stock market could be adversely effected.  Especially the banking sector.  Bank of America (NYSE: BAC) is having a great year this year, but if our congressmen play chicken with the debt ceiling, it is likely investors will flee banking stocks for a second time in 3 years. 

<img src="http://media.ycharts.com/charts/99d53a1692e01938bdedd03873d96398.png" />

BAC data by YCharts

Both Bank of America and Wells Fargo (NYSE: WFC) fell over 20% while our politicians fought back and forth about the debt ceiling.  It finally culminated in the downgrading of the national debt.  When you see a stock fall 20%, it's normally because of something the company did, not something the government did.  But when it comes to the banking sector, it is very much affected by financial decisions in Washington. 

4.  Inflation is Spiking

From July to October this year, inflation rose by nearly 9%.  We have talked about the inflation of food prices specifically, but this is more than just food.  This is healthcare costs, transportation expenses, electricity, rent...even firewood.  This is the whole deal. 

Inflation on one hand is normal, and to an extent, even healthy.  If the economy isn't inflating, then it's deflating, which is arguably even more detrimental the economy.  But 9% is significantly beyond what is considered normal inflation.

5.  Jobs are Still the Issue

I'm so tired of hearing the political promises of creating jobs.  But the reason everyone on both sides of the aisle is still promising jobs is because we still desperately need them.  Many are excited that unemployment fell to 7.8% last month.  And no doubt, we could have received much worse news.  But unemployment of near 8% is astronomical.  It's hardly reason to celebrate.

Our economy has been limping along trying to support unemployment between 7%-10% for some time now. How long will the economy continue to limp along before it buckles under this constant strain?

6.  Gas Prices are Falling

Gas prices have caused the economy problems before, namely in 2008.  However, in 2008 gas prices spiked. This coming year the EIA has predicted that gas prices are going to fall.  Some predictions are calling for $75/barrel gas compared with $147/barrel in 2008.  Is this really evidence of a coming bear market?  

When gas prices spiked in 2008, it spiked because of supply problems.  Several factors contributed to there not being enough gas to go around.  Demand was high.  All the demand coupled with a short supply caused prices to spike.  This quick and sudden spike was good for some companies like ExxonMobil.  Remember the whole "windfall profits" capital hill controversy?  While good for a couple of businesses, it was disastrous for the economy as a whole.

Now prices are falling.  Why is that a bad thing?  The current price is a demand problem.  People don't have as much need for gas right now.  This could be a symptom of a slowing economy.  Where the 2008 gas spike led to a spike in other areas (like food), don't expect the lower prices to translate into consumer savings.  We have already seen how food prices are rising anyway for reasons apart from gas.

Conclusion

I am normally forever the optimist.  But I believe that Sherlock would say my sentiment has little bearing upon the evidence.  I believe all these factors will work together to bring us our next bear market, perhaps in 2013. However, it won't be a kill shot.  It never is.  It's just part of the cycle.  The bear market is coming.  But on the heels of that bear will be yet another bull.  If it's even half the bull that this run was, it'll be spectacular.  I can't wait.


thequast owns shares of Bank of America. The Motley Fool owns shares of Bank of America and ExxonMobil. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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