Bear Market Investing

July 17, 2008 by  


By Bob Wood, MMNS

It is now official! The financial media have agreed at last that the U.S. is, indeed, experiencing a new bear market. With the major domestic stock indices having fallen by more than 20% from their October 2006 peaks, media spokespersons are warning investors with traditional portfolios to make some changes. So what should investors be doing?

This is an easy call for me, since I have been bearish on domestic stock markets for the past few years. My portfolio allocations are already in bear mode and hedged to the hilt. And for now, it’s just a waiting game.  But those investors who have ignored the bearish calls and followed Jim Cramer’s advice instead will find, obviously, that they do need to make some big changes.

The most basic issue here is that we did not enter this bear market in the past week or so. We know, without a doubt, that we’ve been in a bear market since early 2000. How? The S&P 500 index is lower today than it was at that prior peak, and has remained under that peak — for the entire decade. If that’s not a bear market, I don’t know what is!

The bottom line is that savvy investors should have, for the most part, shunned domestic markets for the past few years. If you have been reading this column since its inception, you know that is the key premise I have been advocating. But we can always find a bull market somewhere, and we have found some wonderful bull markets around the world. At the same time, we have found some value here at home, with commodities like oil, gas and gold enjoying stellar runs higher.

Contrary to what you will hear in the financial media, or perhaps even from your broker or financial advisor, bear markets do not end in a year to eighteen months. This bear market still has years to run. And with the S&P 500 still selling at about 20 times earnings, the bear trend still has far to go — to the downside.
Why should the U.S. stock market sell at such a high valuation when Germany’s stock market sells, on average, at 12 times earnings? Why – when Singapore’s market sells at about 9 times earnings and Britain’s stock market sells for 10 times earnings? And when the Swiss market sells for 14 times earnings?

Surely financial and economic fundamentals are not as bad in those countries as they are here. And, when compared to most other smaller markets around the world, the fundamentals here are far worse! How far can our markets fall — just to bring them in line with other developed markets with even stronger fundamentals?

Adding to the troubles lying ahead for the U.S. is how far and fast the dollar is dropping in value. Investors around the world have been buying our shares when they see our markets selling at a discount — based on the strength of their currencies. Likewise, shoppers from Europe have been heading to New York City and other shopping destinations in search of relative bargains.

But as the dollar’s fall continues, those foreign investors face a double threat: lower share prices, which reduce their gains when selling, and less value when converting to their home currencies. In addition, with many more U.S. investors now taking premature distributions from their 401(k) plans, I expect the inflow of dollars from those plans into the stock market to slow.

Reduced demand for stocks will further dampen the mood of the markets, and losses are already mounting for those who are committed to remain invested in ‘’stocks for the long run.’’ Maybe this experience will help send that highly flawed selling strategy into Wall Street’s garbage can — where it has always belonged.

Domestic stock markets have fallen to the same level they held in August.of 2005! That’s right, all gains earned by most investors in the “up” years of 2006 and 2007 have been given back! And when you adjust for inflation, those losses are compounded. How much patience will others muster before giving up, as they try to maintain whatever is left of their savings?

Surely we will see some rallies to the upside, just as we have seen in the past three years. But the indices have dropped right back to where they were at the start of the period. And those rallies, along with all the “happy talk” offered by the financial media will tempt investors to try — and try again — to regain lost ground. Warning: Do not be one of those “die-hard” investors!

Remember what has happened to investors in Japan who stubbornly remained invested in their home markets for the past 18 years. Their losses, in real terms, are staggering. I often wonder how often that country’s financial media encouraged investors to ‘’stay the course,’’ remain fully invested for the long haul or get back into the market for fear of missing the next big rally. And all this was for naught as investors in the Japanese market have been punished again and again for believing what was nothing more than the selling tactics of its big brokers and banks.

I would be not at all surprised to see our home markets perform much like those in Japan for the past two decades. Look at the proof in the stock market valuations, implosion of the housing market, wrecked car market, melt-down of the financial sector (with Fannie Mae and Freddie Mac now begging for taxpayer bailouts), and inflation that is ripping consumer budgets to shreds.

Add to these concerns the unforgivable crisis in leadership found in our government and the Federal Reserve. How can these issues possibly be construed as short-term problems? The U.S. is in financial trouble, and we’re finding fewer and fewer reasons to believe that these situations will end soon — and without investor pain.

Adding even more assurance to my thinking is how current market declines are blamed on speculators, short sellers and dishonest hedge fund managers. Perhaps, if the blame had been focused on the managers of our large financial and manufacturing companies – those who led their companies into such vulnerable positions that mere rumors were cause enough to crater their share prices — there might be some hope.

Markets should always be free and fair. Attempting to backstop losses in those horridly managed, vulnerable companies with government protection from short sellers smacks of desperation. Doesn’t this, too, fit my overall assumptions about where we are and where we’re headed? Many of the rallies of the past few months have been fuelled by short sellers buying back the shares they sold short. Yet no one sees the need to hammer on those short sellers, since the markets rally on their buying!

In short, I see just too much that’s unlikable in our markets, and history strongly suggests that we’ve still a long way to go before the markets find their eventual bottom. You might recognize the bottom when it does come by noting how few people consider buying stocks based on their recent performance and how often single-digit earnings multiples will be seen. And we are now seeing those aspects in some of the European and Asian markets noted above.

Until that happens, my recommendation is get out — and stay out — of most sectors of the domestic stock markets. Don’t listen to the happy talk that promises that “you don’t really have a loss until you sell,” which was actually uttered recently (with a straight face) by a CNBC commentator. Don’t believe them when they say that it’s too late to sell. It’s never too late to preserve what you have left — and survive to fight another day.

We are in the midst of a secular bear market with years yet to run. The best most committed investors can hope for is minimizing their losses, and how good is that? Look for better opportunities elsewhere, and you just may find them.

Have a great week.
Bob

Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., invest@muslimobserver.com.

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