Mind those bear market bounces

Hello to lots of nice people I met this weekend in Vancouver.
I promised that I would post on-going thoughts as this market downturn plays out over the coming weeks and months in order to give readers a sense of what we see next coming down the road.
After almost relentless down days in the first three weeks of 2008, more than half of the world's biggest stock markets have now fallen into a bear market, see Stock Tumble drives 43 Benchmarks into Bear Market (Bloomberg Jan 22, 2008). So much for “de-coupling”! Economists can argue all day about whether the world economy can de-couple from a US led recession in North America, but one thing we can tell for sure–world stock markets are not de-coupling. This stock market meltdown is truly global. All those financial advisors who tell everyone to just spread equity holdings around the world for diversity benefit? Well… you be the judge.
At this point though, major indices are deeply oversold. As a result it is very likely we will see a few days or even weeks of a significant bear market rally from here. We must be aware however, these rallies are likely to be fleeting, relatively short-lived and not alter the primary bear market trend which has now been established around the world. Realize that the last bear (2000-2002) which took the TSX and S&P 500 each down by some –45% before it ended, included three separate rally segments where the market roared back 20% before collapsing again to a final bottom. As exciting as these interim rallies can seem on the screen, they are notoriously volatile and must not be allowed to suck disciplined investors back into the fray.
For anyone who has unfortunately not had a sell rule to get them out of equity markets before this point, these coming rally days may be your last reasonable chance to downsize risk holdings before losses accelerate. Buy and hold advisors are always telling you bad markets are buying opportunities. But in the real world how are you supposed to have money to take advantage of all these buying opportunities if you never sell and protect your capital from the bear market that brings the bargain prices?
US money manager John Hussman writes it well this week:
“the failure to understand the dynamics of market cycles is a major reason why investors repeatedly overextend their risk near market peaks, hold onto their stocks over the full course of a bear market, and finally abandon stocks near market troughs.”
Recently people have been asking me why there seem to be so few “financial experts” who ever talk about trying to avoid down markets? Why do most insist losses are unavoidable and holding and hoping is all one can do?
The best explanation that I can come up with is the fact that the vast majority of financial advisors out there are not actually portfolio managers with a skilled and proven management discipline. This is another way of saying they have no buy or sell rules to manage risk. Most are financial planners, or financial journalists or investment sales people. They have no skill or training as actual money managers, so they know no alternative but to tell people to hold through market downturns. Sadly, the blind lead the blind right over the cliff each market cycle. Personally I find it very sad to watch.
People that have not invested the time and commitment to develop a definable risk management discipline around investing, really have no business giving people investment timing advice. Telling people to never sell equities and insisting that no one can time markets is giving investment timing advice–advice that most are just not qualified to give. (Spreading money around in equities does not count as a valuable investment management technique as world stock markets have shown once again in recent weeks).
Those with a financial planning and sales background should stick to general financial planning advice and leave investment management to those few who have devoted our life work to doing it well. I know of no other profession where the unqualified are given such freedom to run amuck.
People are not pensions! Theory about infinite time horizons and endless cash in-flows should not be applied to individual investors and their finite money.
Richard Russell (writer of the longest running market newsletter in the US for the past 50 years) is one of the few who, like us at Venable Park, has developed his own buy and sell discipline which he has used to limit his exposure to market down turns since 1956. In his January 16 remarks, Russell had this to say to his subscribers, “it's becoming rather clear to me that “down” in this bear market means “down and dirty.” It's “Katie bar the door.” In other words, this bear market is not shaping up as anything vaguely pleasant. No, it's shaping up as an angry grizzly bear. And this bear has been sinking his claws into the throats of investors, not only in the US, but around the world.”
So please mind those bounces. Its still not too late to use them as another opportunity to downsize your stocks and equity mutual funds. And if you are having remorse about the money you have lost in continuing to hold over the past 14 months now, just think of it as the market took back some of the overpayment that it gave to Canadian equity investors for 2002-2006. More is owed still. The bear market is a time when gains that were accidentally made in the bull market are taken away. Anyone can make gains in rising bull markets, but it’s only the ones with some skill and self-control who will keep them.

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