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Five rules for surviving a bear market(ZT)

(2008-01-28 19:53:46) 下一個

Some key moves now will help you avoid the worst of this year's market. If the idea of selling low makes you cringe, think about how you'd feel when stocks dropped further.

Jim Jubak

The signs are remarkably clear: A bear market in stocks is on its way, and it's time to bear-proof your portfolio as much as you can.

There are five things you must do sooner rather than later -- call them five rules for dodging the worst of the bear -- to protect your portfolio before the bear claws an additional 20% out of your stocks.

We won't be in an official bear market until stocks drop 20% or more from their October 2007 highs. As of the Jan. 18 close, the Dow Jones Industrial Average ($US:INDU) was down 14.6%, the Standard & Poor's 500 Index ($US:INX) 15.3% and the Nasdaq Composite Index ($US:COMPX) 18.2%.

Talk back: Is a bear market rally close?

But frankly, I'm not willing to wait for this market to earn its bear stripes. Waiting for a 20% drop means I don't start doing anything to protect my portfolio until I'm already down 20%. I'm willing to risk the chance that I'm wrong because the downside is so significant and because the evidence of an impending bear market in stocks is so convincing.

Here's what I see:

The Dow industrials, for example, show a dangerous pattern of reaching lower lows. Look at what happened after the Dow reached its low for 2007 on March 5. When a rally failed, the index hit a low of 12,861 on Aug. 15. The Dow rallied into October but then fell to close lower, at 12,743, on Nov. 26. On Jan. 8, it closed even lower, at 12,589, and it has kept falling. Just before noon ET Jan. 18, the index fell below its 52-week closing low and its low for 2007. The Dow isn't the worst-looking index, either. The S&P 500 broke through its March 5 low of 1,374 on Jan. 16, and the Nasdaq Composite closed Jan. 18 about 1 point below its March 5 low of 2,341.

Fear is still rising. The CBOE S&P 500 Volatility Index ($US:VIX.X), which uses the volatility of options on the S&P 500 Index to track stock market volatility, is a good measure of fear in the market. A higher VIX indicates more volatility and more fear, a lower VIX the opposite. A break in the VIX below 17.5 in October 2003 showed the downtrend in fear that preceded the huge run in stocks that went on until 2007. The VIX bottomed at 10 in July 2005 and stayed in a trading range below 18 for the next two years. Last July, however, the VIX surged above resistance at 18 and broke above 30. After sinking back to 18 in October, the VIX has been on an upward march again. Fear is climbing, and that's not good for stocks. There are fewer buyers when fear is high.

Wall Street earnings estimates are still way too high if the U.S. economy is headed into a slowdown. Bottom-up estimates for earnings growth for the companies in the S&P 500 -- the total earnings growth you get for the 500 companies in the index if you add up Wall Street estimates -- still call for 16.2% earnings growth in 2008. Estimates have been stubbornly slow to come down. The estimate for total S&P 500 earnings stood at $101 per share at the end of 2007. By Jan. 14, it had inched down to $100.32. As earnings estimates and earnings-growth estimates fall, stocks will seem more expensive, and that's not much of an inducement to fearful buyers. When even well-run segment leaders such as Johnson Controls (JCI.N) and Schlumberger (SLB.N) report disappointing earnings and guidance, as they did Jan. 18, those fears seem well-founded.

Global money flows that propped up U.S. equities are reversing. The debt market crisis that has sucked down banks such as Citigroup (C.N) and investment houses such as Merrill Lynch (MER.N) has prompted a flight to safety among traders who borrowed money cheaply in Japan and used it to buy up stocks and other assets in the United States, Europe, Canada, Australia and elsewhere. To repay their yen loans, traders are selling just about everything denominated in euros or in U.S., Australian or Canadian dollars. You can see the effects in falling asset prices and a rallying yen. A climbing yen just makes the problem worse, of course, as borrowers rush to sell to repay their yen loans before repayment becomes more expensive.

Bad news is still getting worse in the key U.S. housing and banking sectors. For example, home construction fell 14% in December, and new permits fell 8%. In the banking sector, bad-debt problems continued to ripple out from mortgages to credit cards to auto loans to corporate bonds. (See my Jan. 18 column, "The next banking crisis is on the way.")

And finally, many of the world's markets are moving down together, which is scary to traders who believed the damage would be limited to the U.S. As of Jan. 18, the Japanese stock market was down 26% from its mid-July high, the Hong Kong stock market was down 23% from October, the Shanghai stock market had tumbled 13% since October, and the Spanish stock market was down 14% from November. The sense that there's no place to hide is fuelling fear.

For all these reasons, we're going to see an official bear in 2008. But how bad will it be?

Not as bad as the March 2000 to October 2002 bear that gave the S&P 500 a 48% haircut. We're not looking at the kind of collapse in earnings and revenue that we saw then in the technology sector, and we didn't start with stocks trading at anywhere near those nosebleed valuations this time. John Murphy, a technician on StockCharts.com whose work I respect, was, as of Jan. 17, looking for a drop of at least 20% in the Dow from the October 2007 peak, a minimum 22% decline in the S&P 500 and a drop of at least 26% in the Nasdaq.

I believe the bear market loss this time will be more than what Murphy is forecasting but less than the drop in 2000-02. And I'd expect that the duration wouldn't be as long as the 30 months of 2000-02. Remember, fiscal and monetary stimuli take six months to work through the economy. On that calendar, interest-rate cuts announced Jan. 30 or a stimulus package that goes into effect this month or next would start to lift the economy in August or September.

So what should you do if you agree with me that we're looking at a bear market in stocks? I've got five rules for dodging the worst of the bear. They're a result of my painfully expensive education at the hands of the 2000-02 bear and research into how earlier bears have played out. (The best book on the history of bear markets for my money is still John Rothchild's "The Bear Book: Survive and Profit in Ferocious Markets.")

-Sell early. If this is a bear, there's no point hanging around. Sell now rather than later. Why? You want to avoid as much of the bear market losses as possible. You want to avoid being one of those courageous investors who hangs on through a 19% decline but then can't stand it and sells at 20% down. Buying high is one way to lose money in a market. The other is selling low. And that's what you'd like to avoid. Selling now also helps clear your head. Instead of fighting the last battle, you're ready to look forward to making money -- with the cash you've got in hand -- when the market turns in your favour.

-Get over yourself. No investor likes to admit a mistake, and so you hang on to stocks down 20% or 30%, hoping they'll move up to break even in the next bear market rally. And then you'll sell. This sets you up for more losses as the bear runs its course, and it means that you're likely to be selling when the rally that marks the end of the bear finally comes -- at exactly the time when you should be buying. But, hey, investing isn't about being perfect, and making a bad investment isn't a judgment on your moral character or intelligence. All investors make mistakes and pick losers. All we can hope for is to pick more winners than losers.

-Don't count on past winners for safety. In a bear market, almost everything gets sold. Worries about the U.S. and global economy have already taken a big bite out of energy and industrial commodity stocks (copper mines, for example). That's not unusual. Those commodity sectors sold off in past bear markets, too. Looking back to previous bear markets, about the only sector able to buck the trend has been gold. Gold stocks are in their own little correction now because of a drop in sales of gold into India's jewellery market, the biggest market for physical gold in the world. But this is just a correction in gold, which will likely be one of the few havens in any 2008 bear market.

-Cash isn't trash. Rethink your definition of a good return. A 4%-to-5% return might look puny when stocks are moving up 15%, but it's a darn sight more attractive when stocks are plunging. That cash on the sideline can earn you 5% in a certificate of deposit now (keep the maturity short -- six months -- so you can put this money to work when the bear is over). Bonds are yielding less than that now, but with the Federal Reserve expected to launch another round of interest-rate cuts, your total return from a bond could well be higher (bond prices climb when interest rates fall). Stick to safe U.S. Treasurys and to relatively short maturities, such as two years, so you avoid losses from resurgent fears of inflation.

-Hedge with an inverse exchange-traded fund. In the past I wouldn't have recommended anything like this. For investors unfamiliar with options and shorting, a bear market certainly is no place to take a crash course. But with the advent of ETFs -- funds that trade like stocks but hold a portfolio of assets like a mutual fund -- that's changed. You can now buy an ETF that goes up when the Nasdaq or S&P 500 or the Russell 2000 Index ($US:RUT.X) goes down. And you can even buy an ETF that goes up twice as fast as the index that it tracks goes down. So far in 2008, these ETFs are doing exactly what they're supposed to: The Short QQQ ProShares (PSQ.N), which bets against the Nasdaq-100 Index ($US:NDX), was up 13% this year as of Jan. 18. (Be careful chasing returns on the short end. Monday's rout in the overseas market suggests we're getting close to a bear market rally, and you don't want to go short just in time to be killed by a rally. The time to put on a hedge like this is near the end of a rally -- not during the panic that often marks a temporary bottom to a bear market.)

Which mix of these five suggestions you chose to follow depends on your portfolio, your investing horizon and your own psychology (you know how much pain you can stand). The closer you are to needing your portfolio, the more aggressively you should protect it. The less prone you are to panic, the less you need to worry about selling at the bottom. But I think raising cash so that you're ready for the next bull market is a good strategy for anyone fighting a bear.

Update to Jubak's Picks
Sell Pentair (PNR.N): I like Pentair's progress on raising operating margins in its water business. I like the water sector, and I certainly like the company's increasing penetration of Asian markets. But that's all outweighed by the recent lengthening of the U.S. housing downturn -- recent numbers show the bottom is even further off -- and the imminent outbreak of a bear market. I guess you'd say, in Wall Street parlance, that these shares aren't timely.

As of Jan. 22, I'm selling Pentair out of Jubak's Picks with a 23% loss since I added them Nov. 2. This sale raises the cash position in Jubak's Picks to about 31%.

Developments on past columns
"
5 ways to ride out the market's storm": OK, so gold hasn't worked too well as a haven in the past week. Jubak's Picks stock Kinross Gold (KGC.N), for example, fell 13% from Jan. 14 through Jan. 18. But I think this is just a short-term reaction to 1) a temporary rally in the U.S. dollar, caused not by any sudden improvement in the dollar's prospects but by worries about the English pound and the euro, and 2) a huge drop in purchases of physical gold in India's jewellery market.

The U.S. dollar's strength will last only until the U.S. Federal Reserve cuts interest rates Jan. 30 and everyone discovers it hasn't fixed the problems in the economy and financial sector. The drop in gold purchases is a typical reaction to the rise in the price of gold. When gold soars, India's buyers pull back and go from net buyers to net sellers. A pullback of 10% or so usually brings them back as buyers, and I expect the same thing to happen this time. India is by far the biggest market for gold, and spending on jewellery represented about 75% of the 722-metric-ton consumer demand for the metal in 2006.

"Why investing is safer overseas": So it hasn't been safer lately. On Jan. 21, while U.S. markets were closed for Martin Luther King Jr. Day, markets plunged in London (5.5%), Hong Kong (5.5%), Brazil (6.9%) and elsewhere.

And the damage hasn't all been inflicted in the past few days. South America's Lan Airlines (LFL.N), a Jubak's Pick, was down 32% from Oct. 31 to Jan. 18. But I'm going to stick with this stock. Short-term growth continues to hold up. Passenger traffic for December increased 13.8% on a 13.6% increase in capacity. Slightly longer term, in the first nine months of 2007, the company cut operating costs for its air freight business by 2.3%, despite rising fuel costs, by adding more-fuel-efficient planes from Airbus and increasing the length of flights.

I'll also concede the stock's dividend is a big factor. Unlike U.S. airlines, Lan pays a generous dividend: Under Chilean law, the airline has to distribute 30% of its profits as dividends. The company paid out 65 cents a share in dividends in 2007 for a yield, at current share prices, of 6%. In January, Lan raised its quarterly dividend (well, Lan usually pays out three times a year) to 35 cents from 27 cents.

As of Jan. 22, I'm keeping these shares in Jubak's Picks but lowering my target price to $15 a share by November 2008 from a prior $17 a share. (Full disclosure: I own shares of Lan Airlines in my personal portfolio.)

"A safe-money bet? Think Canada": Besides coping with a global bear market, Thompson Creek Metals (TC.N) has had its own share of company-specific problems. On Dec. 14, the company announced lower production estimates for 2007 of 15.9 million pounds of molybdenum instead of the earlier 20.5 million pounds. The problem? Lower grades of ore and harder rock than expected. It didn't help that the company was reducing a target that it had already lowered in November. The result wasn't, shall we say, pretty. Even keeping projections for 2008 at 24 million to 25.5 million pounds and for 2009 at 34 million pounds didn't help the stock. The shares dropped 36% from Oct. 22, the date I upped my target price on the stock, to Jan. 18.

I think the fundamentals in the molybdenum market still look good for 2008. It now appears there will be a molybdenum supply deficit of 10 million pounds in 2007 and of 17 million pounds in 2008. New supplies aren't likely to come into production until 2010, and China has ruled that molybdenum is a strategic material and will begin restricting exports of the metal. I'm looking for solid gains in the price of molybdenum in the second half of 2008 to lift the shares.

As of Jan. 22, I'm keeping the stock in Jubak's Picks but cutting my target price to $24 a share as of December 2008 from the prior $30 by October 2008. Full disclosure: I own shares of Thompson Creek Metals in my personal portfolio.

Editor's note: Please note that recommendations in Jubak's Picks are for a 12- to 18-month time horizon. E-mail Jubak at jjmail@microsoft.com.

At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Kinross Gold, Lan Airlines and Thompson Creek Metals. He did not own short positions in any stock mentioned in this column.

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