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Bear markets in stocks give investors two chances to lose their shirts. Get ready for your second shot at big losses.
First, you can take a huge hit in a bear market if you stay in stocks too long. If you sold out near the Oct. 9 high for the S&P 500, the past nine months have been a non-event. If you held on to what you owned then and maybe even bought more as the stock market rallied in September and October from its August slump, you may be down 20% or more.
Second, you can devastate what's left of your portfolio by getting back in too early. The S&P 500 started the bear market of 2000-02 with a gradual drop from its then-all-time high of 1,527 on March 24, 2000. By Sept. 1, the index was down just six points to 1,521. And then the carnage began, sending the S&P 500 down to 1,103 on April 4, 2001. That was a drop of 28%.
Woe to anyone who thought that was the S&P's bottom, though. A rally to 1,313 -- that's 19% -- in May 2001 was enough to pull many investors back into the market. (I remember vividly because I was one of them.) And then the bear roared back. By Sept. 21, 2001, the S&P was down to 966, 26% below the May 21 high and 12% below the April 4 low. The final bottom didn't come until the index hit 777 on Oct. 9, 2002.
(In this column, I'll tell you how to avoid a second set of losses in today's bear market. So far I've done OK at ducking this bear. For the first half of 2008, for example, my Jubak's Picks portfolio was up 4.9% against a decline of 14.4% for the Dow Jones Industrial Average ($INDU) and a drop of 12.8% for the Standard & Poor's 500 Index ($INX). To see how I've done in the bear over the past quarter, the year to date and longer periods, see my quarterly performance report for Jubak's Picks at the end of this column.)
Safer on the sidelines
So, no, I don't think the drop that, as of Monday, had taken the S&P 500 to a loss of 20.6% from the Oct. 9 closing high -- a 20% decline that marks the official definition of a bear market -- is a bottom. I don't think it was a signal to buy -- unless you're a very nimble trader. And I'm still looking for the kind of washout that sends an "all clear" signal after a market like this.I wish I could give you a date for that all clear. I'm sitting on a 33% cash position in Jubak's Picks (as of July 1), and frankly, I'd rather have the money at work making money than sitting on the sidelines. But at the moment I think the important rule is still "safety first."
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That's especially true because this bear market and this economy have been -- and will continue to be in the near term -- a slow grind lower. We haven't had the sharp decline in either realm that sets up the sharp rebound of the typical "V" pattern. This bear market in stocks has been extremely slow to develop. It hasn't been short on big drops, but decent rallies have followed the declines so that the overall effect has been one of grinding lower. We haven't had a really terrifying flush that's left everybody rushing to sell. And because we haven't, that's left investors curiously optimistic for people looking at a loss of 19% in the index. For example, short selling in the Nasdaq exchange-traded fund, the Nasdaq-100 Trust (QQQQ), is up, according to Erlanger Squeeze Play, to a ratio of slightly over 1, but the short ratio was four times higher in 2003. If investors were truly afraid, they would be betting far more heavily on stocks to fall.
The economy has slowed, but here again we haven't moved from a slowdown to an official recession. Companies haven't been hiring, so the number of new jobs is low, but they've been hanging on to the workers they have for the most part rather than laying them off. That's kept the unemployment rate from soaring. The official rate has climbed to 5.5% in May, up a full percentage point from May 2007, but that means the U.S. unemployment rate is still below the average annual unemployment rate since World War II. In the recession of 2001, unemployment hit 6.3%. In the 1990-91 recession, it climbed to 7.8%, and in 1981-82, it rose to 10.8%. Workers who are still working keep on spending, and that has kept the economy on the growth side of the ledger.
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I think both the market and the economy are likely to grind lower from here. The news on both fronts is likely to be negative, but I don't see anything so negative that it will lead to a panic.
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