The Tycoon Report

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I am frequently amazed at how the mood of stock market investors can vacillate from overwhelming despair to total euphoria in just a small period of time. 

Only a few weeks ago, the weight of the declining housing market, possible recession, job layoffs, and bank failures weighed heavily on the markets and on individual psyches.  Doom and gloom abounded on CNBC and other financial networks.

The day that GE missed earnings, the DOW and Nasdaq absolutely tanked, but soon enough, with the help of some better earnings reports, the market put in what appears to be at least a short term bottom.

Although the stock market feels as if it has recovered in the past two weeks, there are many who doubt that the recovery will endure, and suggest that the market may head lower again to re-test the previous lows.  With this in mind, I thought I would write a bit of a contrarian piece today about what to do should the market start another leg of decline. 

Perhaps the most common question heard from investors when the general market begins to decline is, "Where should I put my money to protect my portfolio?  I could just go to cash, but that doesn't pay very much!"  Quite a dilemma.  More aggressive investors not only want to protect their portfolios from the downside, but ask how to profit from a downturn as well.

One of the many gripes that I have about analysts, particularly those found on financial news shows, is that they often don't tell you what to buy until after the bulk of the trend has already occurred.  By then you may have missed a substantial opportunity, or may even be near the top.  Wouldn't it be better to be prepared in advance for all possible market or sector trends?  I don't need the guy on CNBC to tell me to buy Transocean (RIG) after it has run up from 81 to 160 in the past 12 months.  If I haven't bought it by now, shame on me, and I need to look elsewhere to find the next big thing. 

I have not forgotten the lessons of February 2000, right before the tech crash, when hyperactive pundits were boasting that parabolic stocks like Qualcomm (QCOM) would again double.  I think we all remember how those predictions turned out.

So I want to give you some options today in case this recent bounce in stocks turns out to be nothing more than a short term bear market rally.  My intention is not to predict whether or not the market is going higher, but rather to present some good ideas for protecting yourself and even profiting from the bear market decline, if and when it does return.  You might just want to print and save this article, and tuck it away in a file, labeled "Bear Market strategies".

Let's begin by looking at the period of time from the recent peak of the Dow Jones Industrial Average, to the absolute bottom.  On 10/9/2007, the Dow Jones peaked at 14,164.  Over the next five months, it headed lower, until 3/10/2008, the day the Dow closed at 11,740.  This was the recent closing low.  You may also notice that on January 23rd, an intraday low of 11,644 was reached, but the Dow closed at 12,270 that day.

During that five month period of time, thousands of stocks and ETFs were pummeled.  But not everything went down.  In fact, many ETFs and individual stocks were up quite nicely.  The following is a partial list of various stocks and ETFs that were highly profitable during that five month period (returns in green), and by contrast, several that you might expect to do well during a downtrend (returns in red), yet which performed poorly this time.  All returns are approximate, and do not include any dividends that may have been paid during that time frame:

                                                

Many of the profitable ETFs were those that short an index or a particular sector.  QID is an ETF that double shorts the Nasdaq 100.  DOG shorts the DOW 30, while DXD double shorts the Dow.  SKF shorts the Financials, and SRS shorts the Homebuilders. 

During a bear market, by focusing on the sectors that are the weakest in the market, you can find a number of specific ETFs that will make money by shorting those sectors.  You can also see that gold and silver did very well.  Bond funds like IEI also were the place to be as the stock market sank.  Walmart (WMT) bucked the negative trend of retail stocks because of good earnings, despite the economic slowdown.  Altria (MO) is of course, a well known defensive stock. 

But as the chart above suggests, several of the so called "defensive" stocks did not work that well this time around.  Defensive stocks are defined as stocks that tend to remain stable under difficult economic conditions.  These stocks are found in sectors like health care, consumer products, food and beverages, cigarettes, and utilities.  These are the most commonly touted stocks on CNBC and other financial media sources, as the best places to put your money in a market down trend.  The thinking goes that people may stop buying cars, furniture, or expensive clothes, but they don't stop eating, drinking, or smoking, and they still buy toothpaste, turn on the lights, and get sick. 

Historically, this has certainly been true.  During the long bear market from March, 2000 to June, 2002, the defensive stocks did perform very well.  Over that period of time, MO rose an incredible 240%!  Johnson and Johnson (JNJ) was up 72%, Procter and Gamble (PG) up 65%, Con Edison (ED) up 65%, and Pepsi (PEP) was up by 70%.  However, look at the poor performance of the defensive stocks during this last market down trend.  Could it suggest, as Bob Dylan once sang, that "The Times, They Are A Changing"?

Granted, what you are seeing is a chart of a much shorter time frame than 2000-2002.  Still, something was markedly different this time around.  The bottom line is that one should not just blindly follow the recommendations off financial shows or popular magazines of what used to work.  Instead, you need to do your own research, and follow today's market trends to see where they are going.  It's important to realize that things do change over time, and what worked in 2001 may not work as well in today's environment.  More importantly, products like ETFs have now emerged that may offer profitable alternatives to simply buying the stodgy defensive choices like PG or JNJ.

The best way to find the winners in any market is to check the market movers on a daily basis.  On one of those days when the major indices are all down significantly, and most stocks are in the red, ask yourself, "Which stocks or ETFs did go higher today?  Which ones are showing superior relative strength, compared to their peers within the same sector or when compared with other sectors?" 

Many of the well known financial websites list the sectors and individual stocks that are demonstrating the best relative strength on a daily basis.  The Tycoon Report also features articles every week that focus on new trends that are emerging.  Armed with these resources, you will quickly discover which stocks or ETFs are outperforming, even during a market decline.  It may sound like a lot of work, but really should not take you more than about 10-15 minutes per day to compile a quality list for yourself.

In the same way that using these tools can help you to find the most profitable ETFs and stocks when the market is rising, you can use them to cash in on the next down turn. 

One thing is clear:  There is no longer the need to jump into 100% cash or toothpaste stocks in order to outperform a volatile market.  Surviving a bear market is an old problem, but fortunately for investors, there are new alternatives that go way beyond survival, and actually present wonderful opportunities for those who think outside the box.  Remember, you can profit in any market!