How to Succeed in a Bear Market

Wall Street is known for taking the brightest of minds and curb stomping their faces on the patio out back. In the past 3 months I've learned a lot about the dynamics of the stock market amidst one of the largest crashes we've ever seen. Especially, how accelerations in price evaluations can be expected in certain classes of stock (value vs. growth, small vs. mid. vs. large cap, dividend vs. non-dividend, developed vs. emerging, active vs. passive, credit vs. equity, time-based vs. time unlimited, high volume vs. low volume). I use comparative analytics and Monte Carlo simulation to determine the stocks I hold in my portfolio and the portfolios of my investors.

We've been in a bear market for a year now. I've been selectively bullish since Dow 11,000 --- and that turned to market bullish at Dow 8,000. That said, it could still go lower. I'm out there buying the falling knives and getting slaughtered doing it. What I didn't take into account was that when the entire market falls, it takes great companies with it. And, it takes those great companies to price levels that offer huge rewards for those patient enough to buy in at the right time.

Bear Market Considerations

Value vs. Growth

In a bear market, the growth stocks drop to value stock prices --- as if they are done growing. You see uncertainties like stocks trading below book value, sometimes cash – total liabilities valuations. The trick is realizing that this is coming and just waiting to snatch them up at these ridiculous levels.

Small, Mid, and Large Cap

The first stocks to slide are the small caps, followed like a pack of mountain trailblazers that are strapped together at the waist by Mid and Large caps. As long as you're keeping an eye out for the slide starting, you can try and unhook yourself from the pack to save yourself from peril.

Dividend vs. Non-Dividend

Cramer's been emphasizing stocks that offer secure high dividends that haven't offered yields like this in a long time, if ever. These kind of stocks do have bottom prices because there is a certain point where bond-holders sell their bonds and grab these stocks up with their historically gigantic yields. This gives dividend stocks a bottom price. There are growth stocks out there that don't have this luxury and easily drop below book values, PE ratios of 1, even if they've been growing year over year at 100%+ rates.

Developed vs. Emerging

The first to dive are the emerging market stocks. The BRIC countries have been hammered the worst. Then, you have the mountain climber effect start dropping off the developed economies. This time is historically different from any other time in history, however. Globally, leaders are stepping up efforts to curb their economies back onto the growth track within in the next year.

Active vs. Passive

Active funds are getting sacked; they're out there strong-headedly catching the raining knives. Passive funds show less of the pain. My approach to this was to get into this mess fairly diversified across industries and countries and slowly bulk up on the ones that were getting hammered the worst but still looked to have a strong future.

Credit vs. Equity

The credit market's are the market's that got us into this big mess. That said, you'd be ahead if you were in reasonable credit a year ago instead of equity. What now? If you're smart, you can catch easy safe bond yields at 8%. I would point out that I think if you're smarter, you can buy stocks and sell covered calls and pull 10% off the top. In my opinion, the smartest are buying stocks and expecting a reversion to the mean, since historically when the volatility indexes reach abnormal highs --- that's what is expected.

Time Based vs. Time Unlimited

Basically, this is the difference between stocks and options. As the market plummets, the options get comparatively more expensive. But, they still enable you to catch serious upside or downside.

High Volume vs. Low Volume

The low volume stocks get hammered the worst in times like this. There are just not as many buyers because nobody knows about them.

The Bottom Bear Market Line

In bear markets, the best strategy is to own inverse market leveraged ETFs or long puts that you bought a year ago. The hedge funds that bet that the market is manic-depressive and that the market doesn't do a good job of pricing this in have been lining their pockets with heroic gains for their investors.

What to do now?

We've already been chopped down from 14,000 to 8,000. I'm still buying predictable companies that have more upside than is priced into their stock. I'm always comparing new companies to the ones I hold in my portfolio --- maybe there are better opportunities out there? There are a lot of commentators that just comment on what the market has done and bat ideas around. There are a lot of people out there that run electronic screens to sort out stocks and then comment on the screens. There are a lot of people that achieve market returns and are happy. I believe that like in school, those that do their homework and understand how to value companies can do better.

Comments

[coldcall:]

Nice common sense article Glen; and very much along my lines of thinking.

In this market basic fundamentals are the most important factor in picking the right stocks. Timing should be based on current market movements and historical value analysis of said stock, and the future view and how it will ultimately affect that stock in a recession. I only buy a stock having accepted worst case scenarios will occur.

I think technical chart reading is really stupid at the moment and I've read very few chartists who have predicted accurately. Some of them are now turning itno parodies because they keep predicting the same thing over and over again and it never happens. Just one more time etc...

My point is that charts in a bear market will be driven exclusively by the underlying fundamentals of the economy and the stock traded companies and obviously some panic. So if one correctly reads the fundamentals of the economy and the stocks value then they will be way ahead of the chartists.

Just my opinion of course.

2008 Nov 30 05:25 AM

[coldcall:]

PS: Excellent advice from Glen about the dividends. Most stocks ive bought have been solid div yielders of 5%+. I've noticed they do seem to have a yield floor below which they will not fall, or at least for long. While these stocks did get battered during the sell-offs, they bounced back almost immediately to that yield threshold. It means one can safely buy these stocks at that threshold with less fear.

By the way, I've also been buying falling knives since the beginning of October but currently 5% up since then. I've never traded before September and for some reason got interested when the stock market started tanking.

I believe in fundamentals 100% as a guiding factor for what to buy and what not to buy. The chart stuff is like astrology. The only time i look at charts is for an idea of historical fluctuations/price.

2008 Nov 30 05:34 AM

[rsinj:]

coldcall - if you've only purchased your first stock in September, you have a lot to learn.

Dividends can be eliminated entirely on a moment's notice. Want a good example - look at CCL and RCL. Many of the gurus (like Cramer) were saying these companies were solid, just experiencing some uncertainty due to the economy, but their dividends were solid and provided a reason to hold (yielding 5% to 6%). Well, one after the other - they eliminated the dividend and they both crashed.

The "floor" is a result of "group think" because everyone is doing the same thing - buying up those which are yielding 5%+...because Cramer and others are telling them to. But what happens when the dividend is cut or eliminated? Group think again - the stock is yielding less (or nothing) so it has to go down...significantly because everyone is now going to sell.

Long term, fundamentals usually win out, however, in the short-term, are you able to watch the stocks in your portfolio lose 50% or more and continue to buy and hold? The "floor" causes management to rethink their dividend payment policy. If they're yielding 5% or more, and most others/yields/rates are lower, well, they have incentive to lower the dividend and conserve cash - unless they have no debt, lots of cash on the books, and no need to worry about needing more cash. You will find very few companies like this out there which are yielding above 5% where you can have absolutely no concern of a dividend cut.

As a new investor, this is your opportunity to get a valuable lesson. The only question is, will it be a tough one?

2008 Nov 30 08:43 AM

[Fredrik:]

yes, people who do their homework usually come out on top but that does not mean that studying company fundamentals will necessary earn you better than market returns. it is much better in my opinion to do your homework on such subjects as financial history and market behaviour. a great example is that i will bet you that the when we have hit the lows and a new bull market emerges it will not be the great companies that perform in fact it will be exactly the opposite, the garbage companies will perform extremely well, have a look at financial history instead, everytime this amazes the fundamental stock analysts and the MBA types because it doesnt 'make sense', the fact is its just what markets do...

2008 Nov 30 09:08 AM

[cashew:]

The smart investor got out or went short a long time ago. The smart investor may now be slightly bullish but very cautious with a small position waiting for more solid info before putting more capital to work.


On Nov 30 09:08 AM Fredrik wrote:

> yes, people who do their homework usually come out on top but that
> does not mean that studying company fundamentals will necessary earn
> you better than market returns. it is much better in my opinion
> to do your homework on such subjects as financial history and market
> behaviour. a great example is that i will bet you that the when
> we have hit the lows and a new bull market emerges it will not be
> the great companies that perform in fact it will be exactly the opposite,
> the garbage companies will perform extremely well, have a look at
> financial history instead, everytime this amazes the fundamental
> stock analysts and the MBA types because it doesnt 'make sense',
> the fact is its just what markets do...

2008 Nov 30 10:44 AM

[secmaven:]

Dividends are not the whole story. Many companies pay dividends out of cash flow, ie depreciation expense, that should be reinvested in their capital base to keep the company viable. Other companies pay dividends out of borrowed money as they reinvest their profits in the business and had to take down credit lines, etc. to cover the dividend payout. Bot of these types of companies over time generally have a declining stock price so in the end the dividends you received were an illusion. You were only being handed back your capital investment and asked by IRS to pay a tax on it.

2008 Dec 01 01:11 AM

[Glen Bradford:]

Just because Cramer says the dividend is safe does not mean the dividend is safe. I'm sure there are at least 10 companies yielding over 4% with solid 10 year track records of increased earnings and revenues and aren't in the banking or auto industry. I'm just not into dividends. I'm into companies with huge growth potential, and that type doesn't tend to pay dividends these days. Here's two excellent articles covering 2 facets of why I think the Dow is oversold.
1. Earnings forecasts
finance.yahoo.com/expe...
2. Credit Markets
seekingalpha.com/artic...

2008 Dec 01 05:13 PM

[Glen Bradford:]

Actually, I'll go ahead and say that if Cramer says a dividend is safe, it probably is. He looks into companies and does his homework. What is a bad idea is using finance.yahoo.com's dividend yield to determine your dividend. The highest dividend yields tend to get cut because the stock has fallen for a reason and the dividend is unsupportable.

Jan 03 02:34 PM

[{5U}:]

Try actually looking at a company's 10ks and 10qs, research reports and transcripts.

Cramer is an idiot. He is simply sentiment trying to sell a suite of products. TV show. Books. Website. Cramerica. He is a brand.



On Jan 03 02:34 PM Glen Bradford wrote:

> Actually, I'll go ahead and say that if Cramer says a dividend is
> safe, it probably is. He looks into companies and does his homework.
> What is a bad idea is using finance.yahoo.com's dividend yield to
> determine your dividend. The highest dividend yields tend to get
> cut because the stock has fallen for a reason and the dividend is
> unsupportable.

Jan 03 07:41 PM