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8 September 2017 Financial Analysts Journal Book Review

Anatomy of the Bear: Lessons from Wall Street’s Four Great Bottoms (a review)

  1. Ronald L. Moy

The author of this interesting book weaves together historical events with investor sentiment surrounding the great market bottoms of August 1921, July 1932, June 1949, and August 1982 and provides insights that are useful in identifying exploitable patterns in market cycles.

The 20-year anniversary of the stock market crash of 1987 reminds us that large dips in prices often represent great buying opportunities. It is not self-evident, however, that the period immediately following a market crash represents the best moment to buy. In Anatomy of the Bear: Lessons from Wall Street’s Four Great Bottoms, Russell Napier, a consultant with CLSA Asia-Pacific Markets, analyzes past market bottoms and finds surprising results. As Marc Faber writes in the book’s foreword:

Conventional wisdom has it that great market bottoms, which represent lifetime buying opportunities, occur quite soon after devastating market crashes. Although the crash of 1987 represented an excellent buying opportunity to get into the market, Napier’s analysis shows that investors would have benefited by entering the market some five years earlier.

Napier’s simple approach involves examining the four great market bottoms on Wall Street—August 1921, July 1932, June 1949, and August 1982—and looking for similarities. Traditionally, academics have analyzed the stock market either by trying to model stock price movements or through event studies. Napier, instead, paying homage to Nobel Laureate Daniel Kahneman’s integration of psychological research and economic insights, examines the psyche of the market.

The dataset for Napier’s study consists of some 70,000 Wall Street Journal articles covering the two months preceding and following the great market bottoms. Napier’s goal is to glean some insight into the bear market phenomenon from concurrent sentiment. His focus on the history of bear markets provides important lessons for investors, but as he points out, it is the chapter that is missing from most books on financial history.

Napier follows Andrew Smithers and Stephen Wright in determining which periods to analyze. In their 2002 book, Valuing Wall Street, Smithers and Wright identified the best years in the 20th century to have invested in equities. Using a measure of “hindsight value” that is calculated by averaging discrete returns over periods of 1 to 40 years, Smithers and Wright determined that the three best years to buy U.S. equities were 1920, 1932, and 1948. The requirement of 40 years of returns prevented Napier from computing the hindsight value for 1982, although he believes it may prove to be comparable with the previous three great market bottoms.

In lieu of the more traditional P/E, Napier bases his valuation on Tobin’s q, the ratio of a company’s market capitalization to the replacement cost of its assets. Napier’s key insight is that extreme market undervaluation arises only partially from price declines during crashes. Much of the cheapness results from the failure of stock prices to advance in line with growth in economic activity and earnings.

Napier’s research has uncovered another piece of information that flies in the face of the conventional wisdom that bear markets are surrounded by bad news. Napier’s examination of Wall Street Journal articles indicates otherwise. During all four periods examined, ample good news was reported. Many investors, however, have a hard time seeing the good news after a protracted bear market. Given human nature, this inefficiency is unlikely to change.

Anatomy of the Bear is not only a study of bear markets; it is also a fascinating glimpse into the history surrounding those episodes. The Wall Street Journal extracts that Napier selects, although subject to the author’s biases, provide insight into world events that help explain the behavior of stocks. The events include the attack on Pearl Harbor, the Cuban Missile Crisis, presidential elections, and the Vietnam War.

Only time will tell whether August 1982 turns out to follow the pattern of the previous three great market bottoms. Still, it is worthwhile to recall the widely quoted remark of philosopher and essayist George Santayana, “Those who cannot remember the past are condemned to repeat it,” and to add our own investment version: Those who cannot remember the past are unlikely to prosper from it.

Napier has done an excellent job of weaving together historical events with investor sentiment surrounding the four great market bottoms, complemented by his own analysis and commentary. The book is an interesting read, not only for fans of financial history but also for those with the practical objective of identifying exploitable patterns in market cycles.


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