Bear Markets

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Bear Markets: How to Uncover Profit Opportunities When Selloffs Emerge

by Alexander Green, Chairman, Investment U;
Investment Director, The Oxford Club
Friday, January 25, 2008: Issue #756

I’m not a market timer. But last summer, as the stock market was hitting new highs, I wrote a column suggesting that a bear market lay just ahead.

“At the risk of sounding like the skunk at the garden party, I want to warn you today that there is a big grizzly ahead of us, sharpening his teeth and filing his claws. His goal is to destroy billions of dollars of stock market wealth – and perhaps your hopes and dreams, as well.

Don’t let him do it. And don’t be complacent about bear markets, either… There are many sensible things you can do now to gird yourself against the next bear market…”

This column actually appeared a little early. While the market began its late-summer meltdown a few weeks later, the Dow was back at new all-time highs by October.

Needless to say, few new highs have been hit lately. Instead, investors are now asking what a bear market is, how long it lasts, and what kind of damage it typically does. So let’s take a look…

Defining A Bear Market

A bear market is typically defined as a drop of 20% or more in a stock market index. (A correction is a drop of 10% or more.)

Technically, the Dow and S&P 500 are simply undergoing a correction. But that’s not the whole story. At one point this week, the Nasdaq was down just over 20%. Many overseas markets were down over 20% from their recent highs too, including Britain, Germany, France, India, China and Japan.

Since 1926, the average bear market has lasted 1.3 years and taken stock prices down approximately 30%. Only two of the last 15 bear markets have ended in less than six months. Since 1940, however, more than half of the bear markets have ended in less than a year. Since the Dow peaked in October, that would mean chances are that if this is a bear market, it still has several months to run.

The market has been acting better since Wednesday morning’s plunge in the Dow turned into a 600-point rally. Does that mean the averages are likely to keep heading higher from here, avoiding a bear market altogether?

Not necessarily…

Bear Markets Can Include Declines & Rallies

Bear markets typically include several declines of 10-20%, punctuated by furious rallies. The 2000-2002 bear market included three separate advances of roughly 20%.

Ironically, the only way we’ll know what this market is for sure is when we’re looking in the rear-view mirror. But if you ask me, it’s too late to take most of the bear market precautions the pundits are recommending (as I did last summer). Even if the market declines a typical 30%, we’re half way there already.

So forget about making big bets on bonds, gold, utilities and other non-cyclical stocks. They’ve already had a big move.

When Bear Market Investing Watch For Dividends

There’s more upside buying into sectors that have been slammed… and that pay big dividends.Last Friday, for instance, I recommended buying regional bank First Horizon National (NYSE: FHN) due to its cheap valuation and big dividend. It ended the day at $16.05. Yesterday it closed at $19.93, up 24% in three sessions.

To me, moves like these make more sense that plowing money into Treasuries. They’ve already moved up sharply and yield virtually nothing after taxes and inflation.So think opportunistically. Yes, every bull market eventually comes to an end. But remember too that behind every bear market is yet another bull market.

Good investing,

Alex

Today’s Investment U Crib Sheet

If you’re hunting for selloff-induced opportunities, here are five ideas. The following ETFs track sectors that have been severely “slammed” over the last 12 months:

Exchange-Traded Fund: iShares Dow Jones U.S. Home Construction (NYSE: ITB)
12-Month Decline: -57%

Exchange-Traded Fund: PowerShares Dynamic Retail Portfolio (AMEX: PMR)
12-Month Decline: -27%

Exchange-Traded Fund: iShares Dow Jones U.S. Financial Services (NYSE: IYG)
12-Month Decline: -25%

Exchange-Traded Fund: iShares Dow Jones U.S. Real Estate (NYSE: IYR)
12-Month Decline: -24%

Exchange-Traded Fund: iShares Down Jones Regional Banks (NYSE: IAT)
12-Month Decline: -23%
There’s still plenty of opportunity in regional banks. Take a look at Alex’s column from last week for more information, Investment U Issue #754, The Credit Crunch: 2 Ways to Profit From Credit Crisis Opportunities.
So what’s hot?The iShares Silver Trust (AMEX: SLV) is up 21% over the last three months. You can get the details here, from Investment U #755, Buying Silver: How To Eliminate Silver Coins & Bullion With One ETF.