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Opinion: Few issues appreciate in bear market

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With the media reporting on bad news (think unemployment, hurricanes, congressional hearings, Bernanke’s or Greenspan’s comments, balance of trade, etc.), it can create a macro view that hangs over the individual investor and the markets like a Los Angeles smog.

That kind of news, the “gloom de jour,” can fire up an emotional response for an investor, especially one whose frame of reference is the recent bear market and the declines in value he probably experienced. So he sells, in many cases locking up a loss, taking out a certificate of deposit with a rate lower than a touchdown-point-after, and vowing to not get back in the market until there is less uncertainty.

For the informed and disciplined investor, such reactions often provide opportunities to acquire outstanding investments.

This is not a random act of a zero sum action; it has been pervasive. In the latest measurement of investor sentiment by the American Association of Individual
Investors, a mere 20.7 percent were bullish. Here’s the good news in that number: In the 48 times a bullish sentiment below 21 percent has been registered, all but one of those times the market finished higher three months after hitting the low number.
Let’s look at recent history of this indicator. On March 6, 2009, as the market was deemed by the doomsayers to be sinking to further new lows and the knee-jerk folks were tossing in the towel, bullish sentiment was at 18.9 percent. One year later, the Standard & Poor’s 500 was 60 percent higher.

So, how does one reconcile these gems of investing wisdom?

“Buy when there’s blood in the street,” as Baron Rothschild, of Britain, said in 1871.
Or, “Sell down to the sleeping point,” reportedly from Dickson G. Watts of the New York Cotton Exchange in 1891.

It isn’t really that difficult to do providing one accepts the somewhat salacious metaphor, “When they raid the house, they take all the girls – and the piano player.”

It’s a more colorful way of saying that in a bear market, only a few issues are going to
appreciate.

Accepting that fact, the prudent investor needs to make certain that his discipline and the construct of his portfolio are consistent with his risk tolerance and financial needs.

For example, an income-oriented investor needs the cash flow his portfolio generates. If he has stayed with a discipline of owning issues that have strong balance sheets and earnings streams and provide the level of income that his situation requires, the determining factor in holding his portfolio intact is patience and conviction that he has carefully selected high quality issues.

This addresses the strategy of the serious investor who is not a speculator or day trader, both of whom must operate in a tactical, much shorter, term horizon, and are likely to employ technical analysis and gut feeling. For growth investors, a strict adherence to monitoring price-to-earnings ratios, especially relative to earnings growth rates, revenue growth, trend directions and institutional ownership is important. We’ll talk more about this in a future column.

As the erratic markets of today become more nearly rational different industries, sectors and investing styles will have their day in the sun. Risk tolerance will grow for the “sell-at-the-bottom” investors who, having chosen to not put their funds to work when the equity markets were on sale, will enthusiastically leap in at much higher prices after seeing the markets race higher and afraid of missing the opportunity to make money. He will do well for a while and, as the saying goes, “confuse brains with a bull market,” only to go through his range of emotions again and throw in the towel when markets correct.

Some are destined to repeat the exercise. Others profit from those repeaters, and so we end with another Wall Street saying, “In a bear market, money returns to its rightful owners.”

We hope you are one of the rightful owners.

Clark Davis is a 37-year investment veteran and CEO of St. Louis Investment Advisors, a specialized money-management company. He can be reached at cdavis@slia.com.
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