Bear Markets: Are We Making It Too Easy For Them To Develop?
Friday, February 15, 2008 | Ethan Roberts
My Step Mother called me the other day and reported anxiously that she had lost over $5000 in the stock market in just a few hours. A woman in her late 60’s, and with my Father passing away four months ago, she is in no position to have large portions of her retirement savings lost in a blink of an eye.
Yes, she does have her money professionally managed, including a diversified allocation among stocks, bonds, and cash that is appropriate to her age. But that is no cure against losses in an increasingly volatile stock market.
This started me thinking. She and my Father were from a generation that believed in the gradual accumulation of wealth by investing in large company stocks that pay dividends, and holding on to them for decades. During good times, their faith in the market was reinforced, and during bad times they just held on, hoping for better times to come. A generation of believers in the American dream, they had survived Eisenhower’s heart attack, the Cuban Missile Crisis, Vietnam, Watergate, the 1987 crash, the 2000 tech meltdown, 9/11, and countless recessions.
My Father’s joy was to watch Louis Ruckeyeser and his stock market guests on Friday night, and in later retirement years, to watch CNBC for hours at a time. During bad markets he was pacified by the talking heads, who urged everyone to stay the course and buy stocks on dips. My Father liked to say, "This too shall pass".
My Father’s generation didn’t day trade nor swing trade their stocks. They didn’t have fancy oscillators, with moving average crossovers and buy and sell signals. My Father didn’t have two computer monitors going simultaneously on his desk as his son does. They had stock brokers, who called them a few times a month to urge a buy or sell, and who charged a lot of money in commissions for their advice. There was no $8 online trading in their world. My Father used to say that he never met a rich Technical Analyst. I’m not sure where he heard that oft repeated line… I don’t think he ever met any Technical Analysts.
Anyway, I digress. The point is, like my Father and Step Mother, there are millions of people in America who are invested only with long positions. Their stocks can only go down during a bear market, and other than cash, bonds, or the so called "defensive" stocks, they really don’t have much protection against those $5000 per day losses. The problem for them is that somehow the nature of the game has changed. Investors are now able to increase the chances for a bear market to both develop and ultimately thrive. For example:
At the present time, there are several dozen Exchange Traded Funds (ETF’s) that one can buy that will short a sector, index, or geographical region of the stock market, and act as a "hedge" against a market decline. Some of the more popular ones include QID, which shorts the Nasdaq 100, SDS, which shorts the S&P 500, and DOG, which shorts the DOW 30 stocks. There are also mutual funds, such as Prudential’s BEARX, or several of the Rydex funds, that will short stocks and profit during market declines.
In addition, the stock market rules were recently changed to allow shorting at any time, not just on an uptick as was the previous rule. This makes it significantly easier to short a stock. One can also short an ETF just as easily as a stock.
Today, many younger investors are trading options from the comfort of their homes, using Puts to hedge against losses to their long positions. This was unheard of except among the professional traders on Wall Street in my Father’s day.
I am also seeing an increase in media articles with titles like "Prepare Now To Weather the Bear Market" and even "How to Prosper in a Bear Market". While this could be seen as a contrarian indicator to a market bottom, it seems to me that these articles actually seem to encourage behaviors that could enhance the possibility of a long and pronounced bear market.
So while one generation is clicking away on lightning fast computer screens, grabbing shares of the QID, buying puts, shorting the financials and home builders, another, less savvy, generation is quietly losing their nest egg and their peace of mind.
If America has a really nasty bear market, either now or in the near future, it is entirely possible that one generation of younger investors will grow richer while their older counterparts lose much of their acquired wealth. The question is whether the more savvy individuals will be able to prolong the bear market by continuously trading using more intricate methods at the expense of the "buy and hold" generation.
The irony is that if one generation loses their nest egg, and subsequent ability to make ends meet, the next generation will have to pick up the tab in the form of higher taxes, day to day financial assistance, and/or diminished inheritances.
Given this, can America really afford to make it so easy for the bear to emerge from hibernation and stick around for any extended length of time?
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Ethan Roberts
Chief Investment Officer
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