The S&P 500 rallied over 20% over the past couple of weeks and all of a sudden people are calling for a market bottom. Investors believe that if they miss the turn, they’ll lose the opportunity to recover their losses. However when you try to catch a falling knife, you will get hurt.

Here are statistics from bear market rallies of at least 20% from the Great Depression:

Ibbotson’s Prediction

In the spring of 1974, the Dow Jones industrial average was trading in the 800s and two young men from the University of Chicago made a bold prediction that the Dow would get to 10,000 by 1999. At the time, many people scoffed at their prediction, but today we know their prediction turned out to be dead on. Roger Ibbotson created a research company thanks to this bold prediction and his 10% forecast of long-run stock returns has become deeply woven into the fabric of American culture. Should you expect this type of return for the next ten to twenty years? Don’t count on it.

Over the last twenty years, brokers, financial planners and journalists endlessly repeated the Ibbotson mantra of double-digit stock returns, and today many investors expect it to continue forever. Criticism of Ibbotson’s work has raged for years, and he recently lowered his long-run forecast for stock returns from more than 10% a year to 9.27%. Does that surprise you? What would your finances look like if the market returned 6-7%? Many financial planners use software packages that assume 10+% returns for stocks in perpetuity and if that number is half, many retirees will find themselves working instead of relaxing on the beach.

With short term Treasury rates at close to zero, many investors have purchased dividend paying stocks to generate income. Investors may have been lured by the promise of double digit yields on many stocks, especially financials, but these yields were based on historical payouts, not the future.

Unfortunately with the current harsh economic environment, many companies are quickly cutting dividends to conserve cash. For example, before today Capital One Financial’s (COF) dividend was $1.50/share, good for a 16% yield; however after today’s announcement of an 87% cut in dividend to $0.20/share, the yield falls to just 2.2%. This is turning into a common theme in 2009 as we’ve already seen significant dividend cuts from Wells Fargo (WFC), Pfizer (PFE), General Electric (GE), Bank of America (BAC) and International Paper (IP) just to name a few.

Since the TARP bill was passed in October, over $332 billion have been “committed for investment” to 473 financial institutions (according to Propublica.com).

Here are some more interesting facts:

The investment professionals at Runnymede Capital Management coined the term “Financial Hurricanes” in an article entitled “Surviving Financial Hurricanes” published in the spring 1996 edition of Financial Consultant magazine. In the article, we urged the industry to research financial market disturbances that would likely increase in severity and frequency negatively impacting the portfolios of both individuals and institutions. Sidestepping even a minor portion of a financial hurricane can benefit clients’ financial and emotional health.

With the growth of 401(k) plans over the last 20 years, individuals have become increasingly responsible for managing their own assets. Unfortunately, there is no one to “sound the alarm” indicating when to cut back their equity position. In fact, the industry and the majority of its brokers, financial planners and investment advisors profess that their investment style is to remain fully invested at all times. Their supporting evidence is explained in terms of modern portfolio theory, diversification, and long-term investing. These concepts and theories are great on paper; but in the real world, investors have a limited time horizon and limited savings.

Over the past several years, many articles have been written about the leading university endowment funds which had outperformed the stock market averages. Pension funds and then financial planners tried to mimic this model to produce superior investment results. The picture below may be familiar to you as your portfolio may look something like the pie chart.

A financial planner would explain that asset allocation is a technique that aims to balance risk and create diversification among major asset classes such as cash, bonds, stocks, real estate and commodities. In theory, each asset class has different levels of risk and return and is supposed to create a portfolio of uncorrelated assets, meaning that when one goes down, another goes up. However, we all know that in 2008, virtually all the asset classes moved in tandem as they all declined in unison.