3 ways the next bear market could hit Few people believe the U.S. market is in a bubble. After all, we’ve made all-time highs, numerous analysts have appeared on TV stating the bull market is just getting started, and according to sentiment indicators, complacency is at historic levels. Unfortunately, many investors believe the Fed will save the market, and that every dip is a buying opportunity. When almost no one believes the market is dangerous, that’s when it is most dangerous. Many people incorrectly believe that market bubbles grow quickly and burst. A true bubble is a prolonged period of excess. The longer it rises and the more the pressure builds, the bigger the pop. To gain more insight about bubbles, I recently interviewed stock-market expert Mark D. Cook, with whom I am co-author of “Prepare Now and Survive the Coming Bear Market.” Cook has been warning of a bear market for several months. “The bull has gone out of this market,” Cook says. “We haven’t even moved 2% in 2015. If it’s a strong bull market, there would be enthusiastic rallies and strong volume. Instead, the volume is sick and the rallies are tepid. The only thing that hasn’t fallen into the abyss is prices.” If Cook is right (and I believe he is), although the market could still go higher, it is dangerous to be 100% invested. Although few want to believe there could be a severe correction or crash, you should be aware of what could happen. Keep in mind that all three of the following scenarios end the same way: A sharp dive over the cliff. The difference is how they get there. Cook describes three scenarios of what happens when the market is in a bubble: 1. Head-fakes and lost faith In this scenario, the bubble makes an all-time high but reverses. “The market will slowly make a higher-high, but just by a little bit,” Cook says. “The volume isn’t there, nor is there much enthusiasm. Investors are not overly concerned. And then, the market starts to fall, but rather slowly.” Even though the market keeps going down and is damaged, investors are hopeful it will bounce back quickly, but it doesn’t. It may take three steps down and then one step up. For investors, it’s excruciating because they are hopeful rallies will bring the market back to its previous high, which doesn’t come. Because the bull market is so mature (i.e. over six years old), it cannot withstand adversity, and is permanently damaged. 2. ‘Black swan’ In this scenario, an unknown news event or “black swan” appears out of nowhere to damage the market. “This is a news-induced calamity,” Cook says. Unlike the first scenario, which takes a long time to fall, this market plunges quickly and hard. As it falls, the speed of the decline increases as the prices accelerate to the downside. It is interesting because this is the scenario that most investors believe will happen, which tells me it probably won’t happen like they think.” Typically, an unexpected event comes out of left field that brings everyone back to reality. Because the current market is so vulnerable, bad news could send the indexes over the cliff. If this scenario develops, the market falls fast, for perhaps only a week or two after the initial decline. Then it rallies near the old high and collapses like in October 1987. “In 1987,” Cook says, “the Fed changed their policy in September, raising rates. It was like putting a sledgehammer to the bulls. The market tried to rally but the volume was weak, there was no energy, and fear replaced complacency.” 3. Slow and painful In this scenario, the market slowly erodes. This follows a period where the stock market is in a tight channel and volatility is low. “The market starts going down at a slow pace,” Cook says. “It won’t destroy investors immediately but it sucks the life out of them. On the outside, the market appears healthy, but its internals are very weak. Because this bear market is so prolonged, it is the worst as far as the amount of points lost.” Cook says we had this market in the 1960s. Clients met their stockbrokers and hoped there would be a rally. “But the rally never came,” Cook says. “This market chipped at their soul. The S&P 500 SPX, +0.29% might go down 20 points and rally back 2 points. The market never rallies enough to allow you to get out undamaged. There is no getting out. Each day it gets worse and worse.” If this scenario unfolds, investors holding full positions believe they can bear it, but the pain gets too great. When they finally decide to sell, they have already lost more than half their portfolio. “This dreadful bear market can last for years,” Cook says. “As it continues to fall, the masses hate the market and want nothing to do with it. Only traders survive in this environment. It takes a long while for the bleeding to finally stop.” Which scenario is most likely? Cook will not say, however, but suggests you look at what happened to oil and gold. Remember that bubbles almost always end abruptly as the pressure is released. If you believe any of the above scenarios are possible, then take some money off the table. Once the bubble pops and a bear market is confirmed, it will be difficult to avoid losses. Judging by the overwhelming amount of complacency and hope, the odds are good that one of the above scenarios will occur. Michael Sincere (michaelsincere.com) is the author of “Understanding Options,” “Understanding Stocks,” and “Prepare Now and Survive the Coming Bear Market.”