In a Bear Market Most Stocks Go Down, So What Do You Do?

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We’re knocking on the door of September and already it sounds like there’s a party going on inside. Crunching the numbers this morning from St. Kilda in our new offices, we find the S&P ASX 200 has rallied 42.7% from the March 6th low. That’s a bit less than benchmark indexes in the States. But it is a nice, juicy, tradeable bounce.

So how much more bounce is there left in this market? That’s the question we grapple with today. If you’re into rhetorical fallacies, you might say we’re begging the question. You only assume it’s a bounce if you reckon the rally is not based on an improved long-term earnings out-look.

There are plenty of analysts and investors – many of whom are now filling up our inbox with snarky notes – that contend the worst of everything is over. It’s a recovery. And even if America is stuffed, Australia has its cosy China relationship to power commodities and the currency higher.

Maybe so, put probably not. We reckon it is a bounce in the image of the post 1929 stock market crash. You don’t liquidate a decade’s worth of speculation and leverage in 18 months. It takes years. They started the process in Japan in 1989…and it’s still going on.

But the stock market is not a television show or a graphic novel. It does not have a tidy beginning, an enthralling middle, and a miraculous end. Attention spans are short these days. People expect instant resolution. But the unwinding of a credit boom doesn’t work that way, especially when you have central banks and governments fighting it every step of the way with measures to prevent the needed liquidation.

Consider this our warning then: this rally is on borrowed time. We don’t know when. We don’t know why. But we do know what. And the what is that stocks are going to price in much lower earnings and investors are going to pay less for those earnings. Expect a lot of spring volatility.

Unlike late 2008, though, this is a great opportunity for traders, mainly because you can short financial stocks. The S&P ASX 200 Financial index is actually up 63.5% since the March six lows. We’ve been working with Swarm Trader Gabriel Andre to add short recommendations to his service. It’s ready to roll now, and Gabriel says the financials make inviting targets.

Energy investors ought to take heed as well. Lately there’s been a nice correlation between the oil price and stocks. The better the economy, the better it is for oil and earnings. Both have gone up.

We’re still bullish on energy for a lot of reasons. But if the party ends sometime in September/October/November, you can expect lower oil and energy prices. That means if you have gains in energy stocks, you’d want to think about trailing stops and profit taking. In fact look for profit taking on the share market as a precursor to a new move lower.

It certainly does make for a tricky investment strategy. Energy stocks are some of the few stock we’d really want to own for the next ten years. But stocks are stocks. And in a bear market, most stocks go down. So what do you do?

A more active management strategy is probably what’s called for. But this violates one of those old axioms of institutional investors: do not try and time the markets. The buy-and-hold strategy works when you’re in secular bull market. It also works to the extent that most investors take control of their investments in moments of extreme uncertainty. People end up selling at the bottom and buying at the top as a result.

So why become active when being passive is so much easier? Because your money – and perhaps your retirement – is what’s at stake. You can go along with the media and pretend the last two years haven’t happened, or that they did but everything is better. But remember, these are the people who didn’t see the whole thing coming in the first place. Does trusting them sound like a good game plan?

Of course most of the time, trusting the conventional wisdom/do nothing approach works. Most of the time the world’s financial system doesn’t totter on the brink of a cliff. Most of the time you wouldn’t have to bother reading about outliers, black swans, and worst-case scenarios – the subjects it is our full-time job to explore here in the Daily Reckoning.

But we reckon now IS one of those times. In fact, it’s been that way since the Fed took interest rates to zero in 2003 and kicked off a global liquidity boom in all asset markets. You live and invest in an era of global fiat money. How that era ends is a dead certainty. But when is another question altogether. More on that tomorrow.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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31 Comments on "In a Bear Market Most Stocks Go Down, So What Do You Do?"

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Mike
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Great line: “Consider this our warning then: this rally is on borrowed time.”

I’ve been feeling like that for months.

Everyone succumbs to the law of gravity, no matter how much you dislike or fight it… corrections are a part of a healthy financial system. You can delay it, but it’s like delaying a spanking from your dad. Just get it over with.

Pete
Guest

Thanks Dan, this is a really useful article.

Greg Atkinson
Guest
Whenever a doomsayer has nothing to say they bring out the “Japan” card. Yes we know that a rally off a market bottom will end, but it does not mean the Australian economy will enter a post Japan economic bubble era! Can DR just get over the fact they missed one of the biggest stock market rallies in years and focus again please? Here is my totally useless prediction to match Dan’s “Consider this our warning then: this rally is on borrowed time. We don’t know when. We don’t know why” There will be another rally, I don’t know when,… Read more »
Pete
Guest

Will that rally be in two decades time Greg?

Ross
Guest
I think Dan’s call into resources stocks is an attempt to discern meaningfull value among the fiscal disarray elsewhere. The question however is whether the fiscal ill discipline will support a bullish run to quality in an inflationary environment to drive resource equity prices far higher short term or whether we go back to the debt deleveraging shaking down this asset class and be looking at taking a big hit on these equities in the short term; before eventually the world of rising consumption in emerging markets creates the fundamental energy demand growth he is anticipating. I have an over-riding… Read more »
Greg Atkinson
Guest

Well we just had one rally that according to DR was not on the cards, so I will be bold and say the next one will be within two decades :) Honestly, has anyone on the DR team ever spent any time in Japan apart from in the transit lounge at Narita?

Ned S
Guest

I’d say every mug trader who’s ever heard the word “correction” is predicting one for September or October (and yes I do mean THIS year) – Wouldn’t it be a hoot if we didn’t get one!!!

Lachlan
Guest
I cant see anything has changed since the rally began. The USA is still in an absolutely dire mess. Banks there arent even foreclosing on defaults as quick as they should because they cant afford to damage their balance sheets anymore. A US currency crisis is still baked in the cake as is hyperinflation and more bubble bust ups. Due to the stimulus/consumption approach we are going to see a more severe end to the rally when it finally comes. The lack of attention to date on real GDP growth is just postponing a true recovery further into the future.… Read more »
Justin
Guest

Are you being sarcastic Pete?

Pete
Guest

Yeah Justin sorry I couldn’t help it. Japan is like the case study of all case studies on recession. I wonder what is in store for their future?

(perhaps we’d think that a place so used to recession would be well placed to handle the GFC wouldn’t we?)

Ned S
Guest
A few thoughts Lachlan – One thing that has changed is that Yank banks that were “too big to fail” have gotten bigger. And another is that the American markets are now pretty confident that the US Fed and Treasury and government will borrow against the future and beggar the higher income tax payer before they’ll let their economy take the full brunt of any Austrian economics type logic. And that they’ll keep interest rates low. And in the interim the joint will get a bit more socialist and the pleb tax payers won’t bleat too much because deep down… Read more »
Lachlan
Guest
I actually hope your right Ned. I have two great kids and dont want to see them living through such chaos. But I do err on the “worst to come” side as you can see. As in a period where the bucks gradual decline becomes a sudden collapse. I dont know when, but cant see how the buck can avoid a big hit (dumping). The rate of US mortgage foreclosure now and into the future is staggering. The rate of smaller US banks declaring bankrupt….81 so far and 1000 predicted to fail/merge. Worst of all and in response to the… Read more »
Greg Atkinson
Guest
Pete..yes the recessions have been so tough on Japan that their auto makers have driven G.M and Ford into the ground on their home turf, Japanese companies are buying up Oz companies and not the other way around, and per head GDP in Japan is 20% higher than in Oz. Many Western nations and commentators have looked down on how the Japanese managed their post bubble mess but before we get too smug let’s see how the West handles things. Oh and they have broadband in Japan also…100 Mbps type stuff. If you want to study technology in the 20th… Read more »
Ross
Guest
Ned, Volcker’s high interest rates to suppress inflation created the rust belt last time. The smaller proportion (than now) of debtor US households were funding fixed interest loans. Moving into higher interest rates off a low base in a consumer & services led economy is a far different scenario to that of the early 80’s when Reagan also had the ability to hit up govt debt expansion/stimulus directed into defense and aerospace spending as the economic leader alongside the beginnings of the import/consumer surge which only hit its straps when Clinton-Summers-Paulson sent the debt stimulus private with the funny money… Read more »
Lachlan
Guest

Good points Ross per UST’s in particular does expose the weakness (“level of control”) there.

Note Warren Buffet….”dont bet against the buck” , but he now seems to have lowered his expectations according to a recent article he published. Seems somewhat panicked by US debt levels….he should be, at least after the point where debt exceeds what can be managed.

Ross
Guest

Lachlan, fellow travellers are starting to emerge on my concerns on currencies and are linking it to the VIX. http://www.zerohedge.com/article/dollar-carry-flips-vix-now-tracking-dxy-stocks-pretending-care-about-bonds but they still don’t align with me on the understanding of the short term borrowing / collateral value redemption driver underneath the hot money running home to USD as events turn against their hot money speculation.

Ned S
Guest
I kind of hope I’m right too Lachlan – Compared to the way the USSR (and others) have gone out, the Japanese solution sounds quite liveable. You could be right of course Ross – Which is why Bill Bonner still has his gold I guess. What would be an indicator of it – World markets going down a lot AND the USD going down at the same time perhaps? We saw a crash start to play out last year of course. But that was more the deflationary type crash scenario with the USD getting real strong real quick. I get… Read more »
David (Brisvegas)
Guest

Hey Lachlan,
If you want to go to a beautiful island in the Pacific to escape, I’d recommend Aitutaki in the Cook Islands.
Cheers

David

Justin
Guest

Actually Pete, I had a good laugh at your response.

The RBA leaves the cash rate at 3%, what a surprise!

Lachlan
Guest

Some interesting stuff on that website Ross, some pretty cluey stuff there. Like the currency angle…heaps to learn there for me. Will check it out more now.
David I checked out Aitutaki. Looks very nice indeed but some comments I read regarding the nice people there (warm/relaxed)…hmm just gets better, only I might not get myself out of that water with my hand spear for too long.

Justin
Guest

Hmmmm, just saw the 3 month UST yield chart, which having looked somewhat bearish for a while is now looking bullish, again….Meanwhile, the RBA leaves the cash rate at 3% and I read on the front page of The Sydney Morning Herald the Treasury is telling the government the stimulus must continue.

Lachlan
Guest
Ned when the US dollar index does finally put in a bounce it will be the end of the rally and a fall in PM prices/oil prices IMO. Suppose it remains to be seen what sort of relative devaluations occur ie market indexes vs gold etc etc? Also what sort of flight to safety may occur? Will bonds benefit this time as much as last? Will a higher percentage of fear capital flow into gold vs bonds. There are good reasons to suspect ie after 18months consolidation gold is better value this time. I think the quality of bonds….well the… Read more »
Greg Atkinson
Guest

Lachlan are we seeing a rally as such or simply a correction off levels that were too low? Just as markets rise too far before they come crashing down so do they tend to plunge too low in a market rout. So maybe we are just seeing things reset to where they should be?

Lachlan
Guest

I suppose Greg that I see earnings down since the March rally began, not a good sign but really Im waiting to see a return to government policies which will support business growth (GDP) rather than destroy growth through rapidly increasing regulation/taxation. If ramped up inflation soon puts a bottom under the indexes than maybe price gains may start to look great while real gains, inflation adjusted somewhat poor.
I want to keep stocks if I can though (miners,LNG) so will just play by ear.

Greg Atkinson
Guest

Lachlan there are just some many unknowns swirling around at the moment and these prevent anyone having a clear view of what is going to happen over the next six months or so. I am pretty much doing as you are, playing it by ear and maybe look for the odd bargain. The ETS worries me though, this could see jobs and investment head to nations that manage to slip out of major C02 reductions.

Ross
Guest
Greg, I think the hot/funny money problem will come first. When you get the Tobin tax advanced by the chairman of the UK’s Financial Services Authority you know that such radicalism is being driven by a real fear of disaster (and the weight of the overhanging funny money numbers). http://www.businessspectator.com.au/bs.nsf/Article/Forget-Tobin-tax-there-is-a-better-way-to-curb-fin-pd20090902-VGU5U?OpenDocument&src=sph This takes down so many layers of intermediary and “funding mezzanining” driving the short term speculative stuff floating ridiculous and illogical valuations against fundamentals on anything Goldman says is the bet of the day. NZD/GBP/commodites/major bank equities …. you name it would be shaken down by a Tobin tax, but… Read more »
Ross
Guest

Lachlan, 24hrs and chalk one up for me the “underground dollar bull” as called here.

http://www.zerohedge.com/article/fx-reversal-reversal

But don’t count me as a dollar bull for one day beyond the deleveraging panic having run its course.

Greg Atkinson
Guest

Ross if you are trying to scare me it is working! Actually this is a good example of the unknowns I was talking about…i.e. what crazy idea will governments come up with next!?! We simply cannot predict what people in power will do to get re-elected or what governments will try to raise revenue and pay down debt. I am sure we will see some “interesting” concepts emerge from the Ken Henry tax review.

Lachlan
Guest

Very much appreciate your info Ross.
Are you agreeing with a dollar reversal at this stage?

Ross
Guest
Lachlan, I don’t think the USD will slide backwards incrementally in the short term given normal “managed” events so “normal” might mean status quo. But if there is some compelling shock in the markets anywhere I think the USD will surge higher in the panic to cover redemptions and cover collateral calls for a short period before falling hard on the fundamentals. There are a lot of loaded guns out there that could set off that shock but most of them are regulatory and under US hegemony. I don’t plan betting blind for or against. Lets see what happens at… Read more »
steven perry
Guest

Hey Dan, sounds like you missed the bull run and you are trying to talk it down a bit, to hopefully buy and recover face, heaps amusing. No Analyst can predict the wild, snaking reptile that is the market…no one.

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