ETFs For the Bear Market

Stay diversified if you want to succeed in tough times. This includes my long-time recommendations such as the Emerging Market Bond Fund (PCY) and the Lehman International Treasury Bond Fund (BWX). It also includes the Currency Shares Euro Trust (FXE) and the Dow Jones Commodity Index (DJP).

Indeed, these are tough times. The economy stinks... regardless if we see an official recession that many define as 2 consecutive quarters of negative GDP growth. (Warren Buffett echoed this sentiment with his recent "common sense" definition.)

Similarly, a bear market may officially be defined as a 20% drop from the S&P 500's market highs. Yet any common-sense investor is going to recognize the current state of stock affairs as a bear. Why? Because right now... the stock market stinks!

A brief history of stocks demonstrates the discrepancy between technical definitions and "common-sense" definitions. The S&P lost 19.6% from July to October of 1998. We had the infamous hedge fund failure of Long-Term Capital due to a worldwide currency crisis.

Yet the market went from peak-to-valley-to-peak in approximately 4 months time. Ironically enough, many don't characterize this drop as a bear market at all.

Conversely, we have more painful memories of recession-induced bears... even if the percentage declines are not much different. For example, 1990-1991 gave us a post-war recession, a financial crisis in the savings-and-loan industry, real estate woes and a potential changing-of-the-guard in the political arena.

The price drop was 20.4%... very similar to 1998's 19.6% fall from grace. The total peak-to-valley-to-peak time was 7 months. And in spite of the similar effects on the stock market, many look at 1990 as a "bear" of a time, while looking at 1998 as an aberration.

Granted, 1990 had its roots in a recession, an economic downturn and a financial crisis. 1998 had a single issue... the currency collapse. Nevertheless, the effect on stock prices were roughly the same.

So what should we expect from the current bear? (I am using the term liberally regardless of whether we hit the magic 20% drawdown from the market peak.)

Perhaps the best way to examine the question is to look at the last 3 recession-relevant bear markets. This includes 2000-2002, 1990-1991 and 1981-1982.

The 2000-2002 bear was epic in scope with its 50% losses over 3 years time. Not only did we have the false pretenses of a "New Economy," where stock valuations did not matter, bears of this magnitude tend to occur once in a generation.

The 1990-91 bear market with just 20.4% losses has the most similarities to today in terms of the economic environment. Yet it is the only recession-related bear to require just 90 days to recover from the bottom. And that may be a recovery that is quicker than can be expected here in 2008.

And while there are little similarities to the 1981-1982 bear, other than the fact that we suffered through a recession, the price drop of 27% may be more representative of the potential severity.

Still, the bulk of recession-related bears since 1950 have tended to be in a tight range of 19%-27% declines. That's what we can expect. And in my mind, I believe we will be on the lower end of this range.

There's far too much fiscal, monetary and foreign wealth stimulus to expect worse. Unless, of course, you wish to let fear get the better of you.

Once again, you have to stay diversified to successfully navigate. This includes my long-time recommendations such as the Emerging Market Bond Fund (PCY) and the Lehman International Treasury Bond Fund (BWX). It also includes the Currency Shares Euro Trust (FXE) and the Dow Jones Commodity Index (DJP).

Most important, though, you must also be prepared to use-stop-loss orders on ETFs. This is the only way to insure that no individual position becomes a disaster.

Comments

[couldashoulda]

Mr.G. perhaps you covered this question in an earlier article. Why did you select these particular 4 ETF's?
Good article. Thank you