In This Issue:
The Bear's Usual Game Plan
The Bull Always Slips Back While Nobody Is Watching
What To Do In The Meantime
Investors Can Play The Bear Directly
Oil Isn't Everything, But It's Close
The Bottom Line This Week
Last week the bear wrapped up the nastiest June anyone has seen on Wall Street since 1930, not that any of us were around at the time. At first glance, the final week was not as bad as some that came previously. However, the Bear was handicapped by having only four days to do his work. When the final bell rang on Thursday afternoon, the Dow and the Nasdaq were off another 0.5% and 3.0% respectively that left the two indices off 14.9% and 15.0% for the year.
When the market reopened after the 4th of July weekend, stocks drifted for a day and then shot up when oil prices dropped sharply. Unfortunately, any hope of a recovery died on Wednesday when fresh concerns about the economy sent the Dow skidding nearly 237 points.
The Bear's Usual Game Plan
As any biologist will quickly confirm, predators are smarter than their prey – otherwise they would never get anything to eat. That relationship also seems to be true between the bear and the bull. When it comes to cunning, the bear has an edge.
The bear's usual attack begins with a series of fairly gentle traps in which stock prices drop modestly, and then make partial recoveries. Each trap leaves the market a bit lower than where it started.
For awhile, investors think the downturns are just normal corrections. Because the bull market is expected to resume, investors usually buy into each decline.
In stage two, the bear takes the market down in larger steps that often omit the usual tempting rebounds. After a few big drops, investors realize that the bear has taken control and they begin to modify their strategies accordingly. High flyers and other risky stocks are dumped right and left. In their place, investors turn to defensive sectors such as healthcare and consumer staples.
The strength of defensive stocks in stage two is almost always another of the bear's traps. Investors often conclude that the market's gyrations are "just a routine change in leadership." In fact, we just saw that phrase used again in a financial rag we are too polite to mention. The theory is that everyone will do okay if they are smart enough to take the hint and move into the winning sectors.
Then the bear makes a full-on frontal assault that takes everything down – including the so-called defensive stocks. When investors realize there are no longer any safe plays, they start to leave the market altogether and the decline accelerates.
We think the bear wrapped up stage one a couple of weeks ago and is now into the second phase of his assault. By the end of the summer, stage three would be well underway.
The Bull Always Slips Back While Nobody Is Watching
Fortunately, stage three pretty much exhausts the bear's bag of nasty tricks. There might be another false rebound or two to flush out the last of the closet bulls. More often, however, the market just stays weak for months. Investors become very discouraged and don't want to talk about stocks. The whole market is blacklisted.
It is at this low point that the bull usually makes a quiet reappearance. Although the economy may still look awful, stock values have become so attractive that fundamental investors are compelled to make purchases. Prices start to tick up, but most battle-weary traders stay away.
At some point, stocks attract wider attention and the market starts to make even bigger advances. At the same time, the outlook for the economy begins to improve. Everyone finally realizes the bull is back on the Street and stocks become mainstream again. Hallelujah, and please pass the checkbook.
What To Do In The Meantime
The highest and best use of a bear market is to buy high quality stocks that are pushed into bargain territory, a strategy that has made many fortunes over the years. Although investors may wait awhile for their picks to pay off, they are typically rewarded with doubles, triples, and even higher returns. When the situation is examined closely it usually turns out that the bear market created a lay-up shot for the winning trades.
A big downturn on Wall Street can often prove to be so rewarding –if it is used properly- that we often tell new clients that they should start a monthly investment program and pray for a bear market. The louder the bear roars, the cheaper investors can buy the stocks they need, which means they get more shares each month. By front-loading their portfolios, the long-term gains will be greatly increased.
The same strategy also works well for more experienced investors. Since it is impossible to pick the bottom of a bear cycle, the best plan is to buy top values a little at a time. That way, at least part of your portfolio will have been made at the best possible prices. Bear markets favor grazers not gulpers.
Investors Can Play The Bear Directly
Although picking the bottom of a bear market is more luck than science, it doesn't take a crystal ball to see the trend itself. As we mentioned last week, if this bear has a normal run, we can expect stocks will decline at least another 10% over a period of about six months.
As with most things in life, if you know what's happening you can use it to your advantage. In this case, there are some investments that are structured to rise in value as the market falls.
One of the best bear market investments is the time-tested Rydex Ursa Fund (RYURX) http://finance.yahoo.com/q/pr?s=RYURX that's structured to move inversely to the S&P 500 index. The fund is already doing well, and it should continue to gain at least through the balance of the year.
Somewhat more aggressive investors should consider the Short S&P 500 ProShares ETF (SH). http://finance.yahoo.com/q/pr?s=SH The exchange traded fund effectively shorts the S&P 500 Index and moves inversely to it on a point-by-point basis. If the S&P declines 7%, SH goes up 7%, and so on.
Bolder investors may wish to consider the UltraShort Dow 30 ProShares ETF (DXD) that returns twice the inverse of the Dow. http://finance.yahoo.com/q/pr?s=DXD If the Dow drops 7% UltraShort will rise 14%. How nice!
With both the ProShares ETFs, you must remember that the lever swings both ways. If the Dow makes a big jump, the levers will whack investors hard in their wallets. That will happen if, as many analysts expect, we have a bear market rally before prices start to move down again.
However, ETFs are traded on the stock exchange so you can protect your positions with stop-loss orders. Decide how much risk you are prepared to take, set your stop prices accordingly, and sleep well at night.
Oil Isn't Everything, But It's Close
Speaking of expensive oil, it isn't the only problem that is keeping the bear on center stage - but it is the biggest. As we saw on Tuesday of this week, the Dow jumped over 150 points when oil dropped $9 a barrel. If the drop continues until oil is back into the $120 area, we think the bear will lose its punch.
The Bottom Line This Week
We strongly urge readers to fight the instinct to join the crowd that races for the exits whenever the stock market drops. The flight reaction helped us survive in ancient times when we were hunted by beasts and other humans. In the stock market, however, it pays to move in the opposite direction than the group is taking.
The current situation is a case in point. Although we think we may see a further decline in the market, many stocks have already become very attractive.
At the head of the attractive list are the large multinational companies we have been recommending. We think long-term investors will be handsomely rewarded for buying the many high-quality stocks that are moving into bargain territory for the first time in years.
Since prices may drop more in the coming weeks, the best strategy is to make purchases a little at a time. That way you will get at least some of your position at the lowest prices. Starting to buy now will also guarantee that you will benefit if a rebound comes along sooner than expected.
Until Next Week
The AIA "Advocate For Absolute Returns", a weekly publication of The Association for Investor Awareness, Inc., tracks market trends, industry news, the SEC, global trade and finance and Washington developments for you because they affect your investments. But who doesn't? Many sources report these issues as abstract facts. We feel that's not enough. The AIA Advocate's job is to warn you of what's important and how these developments translate to ground-level forces and threats that directly affect your wealth as well as your current investment opportunities. Not just information, but information you can use. Until next Thursday...
Copyright 2008 The Association for Investor Awareness, Inc. All Rights Reserved
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