Investing Strategies for Today's Bear Market

SO NOW IT'S official: We're in a bear market.

The Dow Jones Industrial Average is hovering around 20% below its peak of last Halloween. Even though the Dow, with just 30 large-cap stocks is the least representative of the major averages, still carries considerable psychological clout, which may be one reason consumer confidence also fell to a 28-year low.

A 20% decline is the traditional measure of a bear market, and other indexes passed that threshold months ago, as I mentioned in my column of March 11, when the Nasdaq was 25% off its Halloween 2007 peak. By my measurement, we've been in a bear market since then, which makes this the ninth month.

How bad are things now? Not all that bad, at least not yet. The average bear market (based on the last 19) lasts an average of a year and a half and marks a 37% decline at its low point. We're nowhere near those benchmarks, and those are averages, meaning some bear markets have been significantly worse. For those of you following the Common Sense system for buying and selling (which last called for buying in January), this is not yet cause for action. The next buying threshold will be 2060 on the Nasdaq, a further 10% drop.

I'm not going to dwell on the causes of the recent renewed market slump: soaring oil and commodity prices and corresponding risks of inflation; no end in sight to the decline in the real estate market; the apparent end of the Fed's rate-cutting campaign. It's not like there's any shortage of causes. On the other hand, this feels different from the lows of January and March. Then there was a crisis atmosphere, and indeed, in the case of Bear Stearns's near-collapse, a genuine crisis. Now it's more the steady drumbeat of higher oil prices and falling real estate, which have generated fears of a deeper recession and further clouded the financial sector. These fears may be perfectly rational, but they're still fears, as opposed to the actual events of March, when the Federal Reserve took extraordinary steps to resolve the Bear Stearns crisis.

As usual, I make no predictions about the future direction of markets. I simply stick to the disciplined approach that relies on where they are now. Regular readers will recall that a few weeks ago I took some gains off the table from the energy sector. (See column of May 13). I did this because oil prices had just hit $125 a barrel, which seemed extraordinary at the time. This was not because the market was at a selling threshold by any means, and ordinarily I would have put those proceeds right back into the market, maintaining my overall exposure. This time I held off, thinking that some of the financial stocks I had in mind might decline a little further.

My timing turned out to be simultaneously good and bad. I never expect to have perfect timing, but I was nonetheless amazed that oil continued its surge to the recent $142 level. If only I had waited a week or two to sell. On the other hand, the plunge in the financial sector accelerated, making those stocks much cheaper. Last week I decided to wait no longer to invest the proceeds. With many financial stocks piercing lows set back in March, I bought long-term call options on American Express (AXP) and Met Life (MET), two stocks I had previously recommended and said I was keeping an eye on.

This continues my strategy of gradually taking profits from the soaring energy sector and putting the proceeds to work in the downtrodden financials. At this juncture I'm only interested in financial companies with the strongest balance sheets and less leverage than the typical investment bank. I concede that in the short term this strategy hasn't worked, but it's way too soon to draw any conclusions.

Meanwhile, if you didn't invest in either of the past two buying opportunities I signaled in January and March, you have another opportunity. The prices of many stocks have been slashed in recent weeks, including many I've recommended this year. The Common Sense approach is to buy lower. One reason it has worked over the years is that's exactly when most people want to sell.

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