Is the Bear Hibernating Already? Doubtful

by David Newman

Finally, stocks are rallying - a bit.

So we can all breathe a sigh of relief, forget about the market carnage we've seen for an entire year. We can lick our wounds and leap back into our favorite blue-chip stocks, without a care in the world... Right?

Wrong. Do that, and you're in for some sleepless nights come October and November. You simply can't trust this kind of market for long. We're in a secular bear market here - that means you're in for a lot more pain for your portfolio before this nasty bear really goes to sleep for the winter.

A Little Q&A with the U.S. Economy

It all goes back to the United States' fundamentals. You have to ask yourself: What's really changed since stocks started rallying last month?

Are the banks suddenly safe? How about the airlines, autos, homebuilders, insurance companies, and restaurants? Are consumers finally spending money again? Did everyone take their nice allowance checks from Dear Old Uncle Sam and go buy designer luggage, expensive Armani suits, new fishing gear or finance their weekend getaways?

(Answer: "Not really" - at least not enough to show a significant recovery.)

Have Freddie (FRE) and Fannie (FNM) suddenly made a miraculous recovery? Did Paulson's magical words somehow heal years of Freddie and Fannie's bad sub-prime loans?

(Answer: Not even close.)

Did the Fed heal entire financial system with their masterfully slashed interest rates and the ability to hold rates steady for months at a time?

(Answer: Nope, but good try Mr. Bernanke.)

Also, it's no secret that stocks rally months before a market actually bottoms. Stocks anticipate a recovery long before we actually see one.

No, in my opinion, we're all going to chew on a few more rolls of Rolaids before this bear is really laid to rest.

Need proof? All you have to do is pick up any newspaper, turn on any TV station, tune into the radio or log on to the Internet, and you'll find your evidence. In fact, I'll bet you can't go more then 30 minutes before you hear or read something like this...

"Fannie Mae, Freddie Mac shares plummet"

"Shares of mortgage finance companies Fannie Mae and Freddie Mac continued their plunge Wednesday (Aug 20, 2008) as investors became increasingly convinced that the stocks will drop to zero if the government bails out the troubled companies."

The Big Whopper of a Bank is Going Under Next

And this came across the wires earlier this week too...

"Kenneth Rogoff, the former chief economist of the International Monetary Fund, reportedly said Tuesday that a large U.S. bank will collapse in the next few months. We're not just going to see mid-sized banks go under in the next few months, we're going to see a whopper, we're going to see a big one, one of the big investment banks or big banks."

Did you hear that? It's not just the small Mom and Pop banks or even medium-sized banks that are in trouble. They're predicting the huge category five storm is going to hit one of the biggest banks in the market. It's just a question of which one...

And what about the homebuilders? Homebuilding was the first sector to fall apart when this uncomfortable bear market started to appear last summer. And you know what they say: "First in, first out..." So homebuilders should be improving right?

Wrong. How's this for a headline?

"Foreclosures smack home prices - down 29.3%" --- San Francisco Chronicle, Aug 20, 2008

Meanwhile, mortgage applications just hit a six-year low. The Mortgage Bankers Association says it will take nearly 12 months to finally sell all the homes still sitting in the market.

Also, constructions plans, which indicate bigger building projects on the horizon, plummeted 32.4% since this time last year.

In other words, we need to build houses to help pull us out of this recession yet if we do, we'll increase inventory, depress prices and accelerate this snowball. How's that for a double-edged sword?

To recap, we're staring at bleeding sectors, more possible bank failures, a hemorrhaging housing market in a recession, and politicians who have NOT managed to fix the fundamental problems yet.

So is a little stock rally really supposed to make us happy? Not hardly.

Your Market Insurance While the Economy Heals

So what are your options when a crazy bear market rears its ugly head?

When the markets are this uncertain, one of my favorite strategies is investing with an "insurance policy." Let me explain. An "insurance policy" can be as simple as a buying both a beaten-down stock and a put option betting against it in the same sector.

This way if the sector starts to bleed once more, your put option hedges your position. On the other hand, if the stock rises, you'll more than recoup the money you invested in your "insurance policy put."

Let me give you an example and one I've recently used. A few weeks ago I thought that the financial sector may have hit at least a temporary bottom. So I recommended buying an ETF on the financial sector to our Sovereign Society members in The Sovereign Individual.

That's a fairly risky bet when the banks still need some time to dig themselves out of this hole. So I hedged the risk by recommending members buy one near the money put option, out about 3 months, for every 100 shares of the ETF. The option cost about 8% of trade.

We call this a paired trade.

If the financial sector rebounds, this ETF take off and members will grab 92% of the gain. If the sector crashes everyone has the put option to soften the blow.

The same strategy can work for you. Hedge your bets and we'll all make it out of this bear market without too many hits...

Comments

[sivleyd:]

Members won't actually "grab 92% of the gain". Instead they will need the ETF to gain 8% in 3 months just to break even on the deal. And if it goes down, they have the put to protect their loss - and give them an assured 8% loss. With each put being 3 months, the annual cost of protection for the ETF investment is well over 24%. That doesn't sound good to me.

2008 Aug 24 04:13 PM

[helplessobs...:]

You have your terms wrong. This secular bear market has been around since 2000. We have just completed last October a cyclical bull market within this secular bear. Since October we are now in a cyclical bear market within the secular bear. Secular bull and bear markets last a long time. The last secular bear ran from 1966 to 1982. The secular bull then ran from 1982 to 2000. We may have 10 more years before the next secular bull market arrives. It will be announced with a blast above 16000 on the DJ with sustained rising prices on heavy volume.

2008 Aug 24 05:16 PM

[whidbey:]

Whatever, the man is correct, we have a nasty ride ahead and equities they are not a place to be. I think flight to bonds will jack up the prices and it will be time to sell them. I suspect the bailouts of the financial group will require billions of newly printed money and interest rates will rise steeply. That is when the markets will suffer as housing goes down the drain, with the dollar following. All the Fed and the Treasury stand helpless by watching the inferno. Did I say oil will likely go up again? Good year to be an Australian.

2008 Aug 24 07:13 PM

[FWallace:]

We americans invested in the US Markets are doomed!

2008 Aug 24 08:59 PM

[Louis Paquette:]

How about a flight to gold?

The Dollar is being debased with these endless bailouts, record deficits, and record debt.

2008 Aug 25 12:07 AM