INVESTING IN A BEAR MARKET - STRATEGIES

‘‘History never looks like history when you are living through it. It
always looks confusing and messy, and it always feels uncomfortable.’’

John W. Gardner, 1968

BE NOT AN OPTIMIST, NOR A PESSIMIST, BUT A REALIST
The hardest part of developing a portfolio in a bear market is human
nature’s natural optimism. There is a saying that man can live 30 days
without food, 7 days without water, but only a few hours without hope.

What is a bear market ?

A bear market is a depressed or declining market. One can have a bear
market in real estate, advertising, automobiles, art, commodities, bonds
, or anything else—including the stock market.

SOMEONE HAS TO BE A BULL OR BEAR
BE NOT A BULL, NOR A BEAR, BUT A REALIST

A bear is not (at least should not be) a permanent pessimist. Nor
should a bull always be an optimist if he is wise. Both should try
hard to be realists.
You should be able to change from a bull to a bear or a bear to a
bull, as conditions change, and not be the least inconsistent.
Some people are permanent bears, and give the symbol a bad name.
Permanent bears often have a puritan ideology that sees prosperity
and bullishness as some kind of Original Sin.
Likewise, many people are always bullish, obviously without
sufficient justification. The almost continual bull market from has
made most people permanent bulls. It has been impossible for them to
accept that any downturn is more than a short-term correction. But,
in any market,the flexible realist is the winner—the man or woman who
can switch directions overnight.
A proper bear is someone who used to be a bull but became a bear as
conditions changed.
What is short selling ?
Short selling is the opposite of normal (long) stock positions.
If you buy a stock hoping it will go up, you are ‘‘long’’ of the
stock. But if you think the stock will go down, you can sell it first,
and buy it anytime you please. This ‘‘short selling’’ is a simple
borrowing-of-stock process that is handled by your broker
with no need for you to understand how.
Why is short selling unpatriotic or negaitive ?
Some think being a bear and/or selling short is in some way
unpatriotic or negative. They believe that to invest your money
in the industry of your country and lose it is more patriotic
than to ‘‘sell those industries short’’ by selling their stock
short—or simply selling out completely because you feel we have
entered a bear market.


Some facts
Even advisors claiming to help you recession-proof your portfolio
cite people like Warren Buffet who made his fortune by buying and
holding, regardless of short- and medium-term fluctuations.
Most advise all non-professional investors to do the same, unless
they are getting near retirement age, when switching into ‘‘bonds
might be safer.’’ What these advisors fail to
mention is that it is only since 1982 that buying and holding
has paid off over the longer term. JFK's father , for example,
made his family’s fortune by short selling in the bear market .

BEAR MARKETS ARE INEVITABLE

Why we have bear markets?
Many think we should have progressed far enough in social
structure, in government guarantees,floors, and protection
that we should have no more depressions, recessions,
or bear markets. But to so think is to say we have changed
human nature and repealed the law of supply and demand and
stopped the pendulum that swings from surplus to insufficiency.
Usually when government tries to manipulate prosperity,
instead of allowing the business cycle to take its course, they
make matters worse. For they destroy the price mechanism that
lies at the heart of our free markets’ system.

GOING TO EXTREMES

A bear market in stocks comes about because the prices get too
high in relation to their value. This is caused by public enthusiasm
that gradually becomes excessive, appraising stocks out of proportion
to their ‘‘true’’ earnings.
It is the nature of such things to go to extremes in both directions.
So, as a bull market often goes too high, so too does a bear market
go too low. The excesses are caused by human emotions.

THE FALSE PROPHETS

One of the aspects of depressions, recessions, and bear markets
that is most difficult to understand is the ‘‘false leadership’’
or false prophets that are prevalent during these times. If
they suspect (from government data) the business future is grim,
they will rarely reveal this if they can avoid it. And what must
be revealed to the public is distorted or delayed or colored.
This is only human. Nobody wants to lose his or her job, and
recessions and depres-sions usually cause politicians to lose
the next election.
The talking heads on television have a vested interest in talking
markets up to maintain their station’s advertising revenue, and
their jobs. Vested interest is knee-deep in the TV and mass media
worlds.

WHAT CAUSES A DEPRESSION?

Depressions or recessions are caused by basic economic changes of supply or
demand or credit. Talk just doesn’t matter. If an apple is rotten, the act of saying so will not make it ripe. If it’s ripe and someone calls it rotten, it will not turn rotten on the spot just because of this characterization.
One basic approach was defined by Charles H.Dow in a Wall Street Journal editorial of July 7, 1900. This premise still holds today. He called it: ‘‘The Great Law of Action and Reaction.’’ Today, it is generally known as ‘‘the 50% principle."

Following a major market advance, if, on the subsequent correction, the
(Industrial) Average holds persistently above the halfway (50%) level,
the odds favor the highs again being approached (or bettered).
Conversely, following a major advance, if the subsequent retracement
or correction goes below the 50% level, the primary direction can be
considered to have turned down. The preceding lows may then be
approached (or passed).

Following a bear market, if a bull move succeeds in retracing 50% or
more of the previous bear market decline, the odds then favor a new
bull market’s approaching or bettering the old bull market high.
Following a bull market, if the next bear market succeeds in erasing
more than 50% of the total bull market gains, the odds then favor the
bear market’s testing the old bull market low.

BEAR MARKET FREQUENCY RATIO

There has been a bear market every 4 years on average.
The decade of the 1990s was unique and, like the bear markets of 1987 and
1990, occurred because of a unique set of circumstances that are unlikely to
repeat, let alone be considered a new paradigm for bull markets in the future—
at least not in our lifetimes.Thus, the investor must try to understand bear markets better. Otherwise,the profits from the previous bull market are usually wiped out.

AVERAGE PERCENTAGE OF VALUE LOSSES
The percentage of decline in bear markets ranges from as little as 13.9% up to 90%. The total of all these percentage losses is phenomenal. The losses represented by all these declines are staggering, but when you realize that the blue-chip averages never fall as far as the great mass of small cap stocks, the damage to your wealth during a bear market can be more than most people can deal with. The averages mask a greater percentage fall by the majority of stocks not in the averages.

LENGTH OF BEAR MARKETS
Bear markets have been as short as 2 months and as long as 5 years, the
average being about 18 months.

TRUE RISKS ARE STAGGERING

The average investor (90% ofinvestors) can’t be expected to spot the exact top of bull markets and sell out in time. This means he loses much of the prior rise before he does sell.
PERIOD OF READJUSTMENT

For those who still believe that if they hold on they will do better than if they
sell at a loss, let me reveal another statistic.
Most of the bear markets took many months or even years to get back to where they were before the fall.

LEARNING FROM THE PAST

‘‘I saw a new heaven and a new earth . . . and the former things were
unremembered.’’

So too with many economists and market analysts, who compile the data
from past bear markets, and then search current market conditions for an exact
match with past models. Any future bear market will be sufficiently unique and
there will be sufficient ‘‘proof ’’ that this bear does not fit any prior model, to
enable people to deny that it is happening all the way into bankruptcy.

SIGNS A BULL MARKET IS ENDING

(1) The most important indicator that a downturn still has a long way to go
is when investor sentiment is still bullish while the underlying economic
structure continues to weaken.
(2) Price earnings ratios. n his book Irrational Exuberance, Yale professor Robert
Shiller points out that, since 1870, price earnings ratios for big
companies have averaged just under 13 for a yield of 7.75%.
(3) Consumer and Investor Confidence. There is always an abundance of
confidence in the future of business and the market, at peaks. Even after
markets turn down, as long as that confidence remains high the bear
market has further to go. Markets traditionally turn around on low
volume in the middle of widespread gloom about the future. Those
who buy at the very beginning of major bull markets or sell at the
beginning of bear markets

(4) Gold. In times of uncertainty, the interest in gold and gold shares picks
up.
(5) Real Estate. It is normal for real estate prices to rise with stock market
prices. There is usually a lot of public speculation in real estate at bull
market tops. Whether real estate turns down in a bear market depends
on how much inflation there is. In inflationary bear markets, real estate
is seen as a haven and prices rise. In bear markets where inflation is low
and the currency firm, real estate prices will usually stay firm in the early
stages, but will decline as the bear market deepens.
(6) Stock market action. At tops, there is what is commonly classified as
‘‘churning’’ (i.e., high volume but not much change in prices, or great
irregularity in prices [some up sharply, some down sharply], plus a lot of
volatility day to day).
(7) Unanimity of bullish forecasts. Business leaders, brokers, advisory
services, columnists and broadcasters are, in the main, bullish. Any
downturn is dismissed as temporary.
(8) Sharp rise in debt. At the top of a bull market, the pervasive mood is
that one can make a profit in markets, without risk. Consumer debt,
household debt service payments, losses by credit card issuers, bank-
ruptcy filings and mortgage delinquencies all rise sharply.

SIGNS A BEAR MARKET IS ENDING



1. Bad news abundant. The stock market always seems to start up before
the bad news (about lower industrial production, unemployment, lack
of consumer confidence, etc.) stops. At that point, the market will be
acting ‘‘contrary to the obvious,’’ which is usually a good sign that the
market is right in whatever it does.
2 Credit. Still tight. But credit balances in brokerage accounts usually are
considerable. Large holdings in bonds and other cash-related invest-
ments. This latent buying power is what will give a new bull market
its stamina.
3. Stock Market. Volume low, not much interest. Stocks selling at low
price earnings ratios, high yields. But then new lows in the DJIA and
S&P occur on even lower volumes. Some key stocks begin to show good
rally potential. Volume tends to increase on rallies, decrease on dips.
Charts are the way to spot this.
4. Confidence. Nil. Pessimistic forecasts made for the market and for
business.
5. Real Estate. Unless it has been an inflationary bear market, real estate
prices will be down. It is hard to sell property. Lots of empty commer-
cial buildings. Rents reduced. Foreclosures rise.
6. Bonds. Government bond buying is popular. Corporate bonds are high,
yields low.

THE EFFECTS OF GLOBALIZATION

Today, the world is so interconnected that the economic problems of any
nation spills over to every other nation. Everybody exports to everybody
else, so when one economy contracts, all those who do business with the
problem economy are affected.
You may have no interest in investing outside your own country. But you
cannot afford to ignore what is happening in other countries. Economic
problems abroad can be a leading indicator of possible problems at home.
THE HOUSE OF CARDS EFFECT

In our interdependent world, it’s a house of cards no matter how you stack it.
We stand together or fall together.
Today, the global economy functions much like a major city. ‘‘Pockets of
prosperity’’ amidst adversity, be they cities, neighborhoods or entire nations,
have become rare
In the last 20 years, a number of foreign funds came into being, and conven-
tional wisdom was that a portion of a well-diversified portfolio should be
invested in other countries.
DOWS THEORY OF BEAR AND BULL MARKET

A bull market leg swing is a broad upward movement of stocks, while a bull market reaction is an important decline against the primary trend. However, under Dow
Theory, during a bear market, one must reverse the terminology.
In bear markets, the primary legs are downward while the secondary reactions, or
rallies, are upward movements against the prevailing primary trend.
Every bear market is made up of two or more downward legs (primary
swings) and at least one secondary reaction.

What is a secondary reaction ?‘
‘Secondary reactions,’’ according to Rhea, ‘‘are as necessary to the stock market
as safety valves to steam boilers.’’ In other words, when the stock market
steam engine is straining and too many passengers have climbed aboard, the
safety valve (secondary reaction) is released. Although many reasons are
given for every move of this kind, it may be said that all secondaries serve
the following purposes:
(1) to correct a primary market movement that has gone too far in one direction, but where the underlying economic reasons for the primary direction have not changed enough to cause a reversal of the primary trend.
(2) To dampen the speculative ardor of the amateur trader.

Following a reaction in a bull market, a base is formed at or near the reaction
low, and it may take weeks or even months of accumulation before stocks
begin the next bull swing.
The explanation is simple: After a bull reaction, investors begin accumulat-
ing stocks and this is carried on as close to the lows as possible. But bear
market secondaries, in contrast, often present a bouncing or turn-on-a-dime
appearance; the rallies seem to spring from no visible base or area of support.
Again, the cause is evident. Bear market reactions invariably result from a
technical condition in which the market becomes oversold. The turn to the
upside may be set off by professional short sellers who realize the time has
come to cover.
Amateur short sellers, having made their move too late, quickly follow the
professionals’ lead. Floor traders, sensing the reversal, throw the weight of
their buying behind the market. Thus, the rally is on. Obviously, such a
phenomenon is not a forecast of a fundamental turn but merely a technical
rebound in a market that has gone too far too fast.
Dullness following the peak of a bear market rally is a common danger sign.
However, it is often confused by the average investor who fails to realize that
the old adage, ‘‘Never sell a dull market,’’ does not apply when the primary
trend is down. Dow was the first to recognize the implications of dullness.

ACTING ON REACTIONS
Very long-term investors can ignore secondary reactions if they wish, but it’s a
difficult if not dangerous course and one fraught with sleeplessness.
The definition of a long-term investor in a bear market is one who holds short
positions for the entire life of the bear.
It’s always best to move in and out of the market in conjunction with secondary
movements. Some of them retrace two-thirds (more or less) of the prior move,
and this possibility is too large just to ride out.
The short-term investor has no choice but to sell and buy in accordance with secondary moves. Thus, everyone needs to understand them and invest with them.