What to Do When We Fall Into Bear Market Territory

by: Bret Jensen

Can we call it a Bear Market yet?

The market downturn accelerated last week as the S&P plunged 5.03%. The market lost ground during every day during the trading week, something that has not happened since late in 2008; an ominous sign. Even more negative in my mind is that analysts are starting to mark down earnings estimates for the first time in a year. I think this process will go on for some time as it is becoming obvious that the economy is slowing down rapidly based on various reports varying from May retails sales, housing starts, Friday’s anemic job report, manufacturing…etc... It looks like it is going to be a very bumpy ride for the markets in the second half of the year.

Watching this market over the last two months is like going to a baseball game in the Bronx. We are now in a situation akin to the Yankees having a three run lead and having Mariano Rivera come in the game in the ninth to close it out. You know there is 99% chance the game is over, you just don’t know if the Great Mariano will have to face 3, 4, or 5 batters before the final out is recorded. The market feels the same way right now to me. It is getting more and more certain that we will hit the 20% down mark from the market top that will put us in an official bear market, we just don’t know when yet. We are now approximately 16% off from the peak on the S&P, which was achieved on April 23rd. Given all the bad news out there (anemic job growth, the European debt crisis, a slowdown in China, a moribund housing market etc…), when will we give up the last 4% and surrender to the Bear?

My own opinion is that we may have a minor rally going into this coming earnings season simply because we have given up so much ground in the last eight weeks and we might be a bit oversold here temporarily. I might lighten up a little on the shorts in our portfolio that have done so well in the last couple of weeks (Baidu (NASDAQ:BIDU), Sotheby's (NYSE:BID), Intuitive Surgical (NASDAQ:ISRG), Lululemon Athletica (NASDAQ:LULU)) and look to reestablish them if/when we have had a slight uptick. However, I think we will be heading into official bear market territory by the end of the third quarter. I can see several events that will trigger the selloff to officially get us into Bear Land.

  1. We get another one or two negative monthly job prints in the third quarter. Given that we still have a couple hundred thousand of laid off census workers yet to show up in the monthly figures, petering off Federal stimulus, more job cuts necessitated by state’s balanced budget needs, and anemic private sector job growth; I believe this is a highly probable event

  2. Any major downgrade or credit issue with a European Bank and/or sovereign debt in the Euro Zone. Another highly probable event. My money is that Spain will be forced to get additional assistance by the end of the summer given the trend of the CDS rates on their debt and the impact of austerity measures on the country’s economic growth

  3. Continued abysmal figures from the housing market. I think it is obvious from the reports in the last few weeks; the housing market is not turning around anytime soon and seems to be dead in the water after the expiration of the home buying tax credit.

  4. More evidence that measures the Chinese government has taken to slow lending is leading to a slowdown in growth in that country. This will have implications for commodities as well as overall worldwide growth. Given the 40% decline recently in the Baltic Index, I think this is another highly likely event

It will be interesting to see how the market reacts once we passed into bear territory; my guess is the reaction will not be positive. Given this outlook we believe the best strategy is to stick to those equities with pristine balance sheets, rock solid business models, reasonable valuations, and decent dividend yields and keep a decent portion of your portfolio in cash until the economic situation has more clarity and a more positive outlook. These “Blue Chip” stocks include (Vodafone (NASDAQ:VOD), Pfizer (NYSE:PFE), Johnson & Johnson (NYSE:JNJ), Exxon (NYSE:XOM), American Electric Power (NYSE:AEP), Microsoft (NASDAQ:MSFT), AT&T (NYSE:T), etc). Be careful out there.

Disclosure: Long VOD, PFE, JNJ, XOM, AEP, MSFT, T....Short BID, BIDU, LULU, ISRG