Finding New Opportunities in Volatile Markets

Don’t look now … but the WORST month for stocks has just begun!

Historically, the month of September is the absolute worst month of the year to be invested in the stock market!¹

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And there aren’t many reasons to think that this year will be an exception. After all, recent economic data hasn’t exactly been encouraging …

• The US economy crawled ahead at just a 1.6 percent annual pace in the second quarter … after yet another sharp downward revision, this time from a previously reported 2.4 percent GDP growth …
• Housing appears to be in freefall once again. New home sales dropped 12 percent to the lowest level EVER recorded, while existing home sales plunged 27 percent in July — the lowest in 15 years …
• And the unemployment rate still hovers close to double-digits with a persistently high number of claims for new unemployment benefits.²

The dramatic shift in market sentiment from July to August as a result of this dismal economic data is palpable, signaling we’re at a point of maximum uncertainty for markets and the economy right now.

• Uncertainty about the potential for a double-dip recession …
• Uncertainty about the true health of the global economy …
• Uncertainty about tax and economic policies heading into 2011 …
• Above all … uncertainty about where the markets are headed.

It’s like riding a rollercoaster in total darkness … without knowing when the next stomach-churning drop or sharp turn is coming.

Not surprisingly, this uncertainty is driving many investors to simply throw in the towel and move to the sidelines. But experienced investors know that where there is uncertainty … there are usually opportunities to build wealth too.

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By spotting these opportunities early — perhaps ahead of the crowd — it’s possible to position yourself to take advantage of the market’s next move.

What Follows in the Aftermath of Financial Crisis?

In the aftermath of a great financial crisis, the economy and financial markets rarely return to business as usual right away. Instead, the healing process takes time. That time is usually measured in years — if not decades — but rarely is it measured in months.

Consider the market pattern after the Great Depression …

Investors during the 1930s and early ’40s witnessed years of false starts and volatile swings in sentiment. There were many bull AND bear market moves over the years while stocks went basically nowhere for two decades!

Or take a look back at the blueprint for investors during the 1970s and early ’80s …

Once again, plenty of sharp ups and downs in the market, but the Dow was no higher in 1982 than it was in 1966 — 15 years earlier!

This pattern is also reflected in other developed economies. Take Japan as a more recent example. Its asset bubble burst in the late 1980s …

And its secular bear market has persisted for the past 20 years and is still lingering today.

Classifying the Typical Patterns

Each of these are classified as secular bear markets but all are similar in the fact that they were separated by vast amounts of time — generations apart — and in Japan’s case, separated from us by vast geographical and cultural differences.

But each severe financial crisis followed a similar pattern …

They all result in a sharp bear market decline. What comes next is a powerful rebound rally. Then, this big rally comes to an end only to be followed by another sharp correction. The final stage is a broad trading range that settles in and can stretch on for many years.

Researchers at Morgan Stanley poured over market data stretching back nearly a century, studying 19 major secular bear markets in all. They noticed the same thing that we did in the three examples above.³

They found the same general pattern repeats over and over again. Their findings are summarized in this graph:

Stage #1 — Major Bear Market Drop: The median decline was -57 percent peak-to-trough over a period of 30 months. This is usually triggered by a severe financial shock of some kind …

Stage #2 — Sharp Rebound Rally: A robust 71 percent gain over 17 months, on average. This knee-jerk rally is often triggered by massive government intervention — throwing everything at the crisis to avert it or stop it …

Stage #3 — The Next Correction: In this stage, investors finally realize that perhaps the rebound rally was just temporary “stimulus” spending — not much more than smoke and mirrors …

Stage #4 — Broad Multi-Year Trading Range: Reality sets in as investors realize the economy faces real, structural challenges that may take years to fix.⁴

It takes a lot longer to clean up the pieces after a bubble bursts than it took to inflate the bubble in the first place … longer than most investors realize at the time.

But it’s this trading-range stage that’s a real “meat-grinder” with plenty of sharp ups and downs in financial markets as the post-bubble economy struggles to adjust to a new normal.

The Historical Pattern is Repeating

If you’ve been watching the markets, you may look at this pattern and say, “No thanks! I’d rather be out of stocks entirely because I don’t want to put up with this seemingly never-ending stretch of volatility.”

BUT, some of us may see something else in this pattern … opportunity!

Each twist and turn in the market can offer you the potential to earn short-term gains — provided you’re willing to follow a more dynamic, proactive approach within your investment portfolio.

[Editor’s Note: Learn the secrets of dynamic investing. Go here now to sign up for Weiss Capital Management’s free Webinar.]

Take another look at the chart of Japan’s Nikkei Stock Index, above, then consider the following stat: During this period, the Nikkei managed to rack up over 434,000 cumulative rally points, even though today, the index sits well off its 1989 high. In other words, there were a lot of up and down opportunities in between.⁵

Similarly, the Dow sits at around 10,000 today, just about where it was back in 2000. But over the past 11 years, the Dow has managed to accumulate 130,000 rally points when you add them up. And there could be many more in store for investors over the next several years.⁶

Keep in mind that these are short-term, tactical trading opportunities that you MAY want to pursue, but only if you’re comfortable with trading more aggressively.

Let me explain.

We’ve been following the typical post-bubble, secular bear market pattern almost exactly since the financial crisis began in 2007.

• First, we suffered an epic bear market decline — a peak to trough drop of 57 percent for the S&P 500 … right on target with stage #1 …
• Then we witnessed an equally spectacular rebound rally of more than 75 percent from 2009 until the peak this past April … stage #2 complete …
• Now, by my reckoning, we could be somewhere in the middle of stage #3 … the correction since April has, so far, taken the market down about 15 percent!⁷

If we keep following this blueprint, then the next stage could be a long, drawn out trading range lasting for the next five or six years. There will be plenty of ups and downs along the way, to be sure, but don’t expect stocks to make any real, long-term progress.

[Editor’s Note: Learn the secrets of dynamic investing. Go here now to sign up for Weiss Capital Management’s free Webinar.]

In other words, we could easily see the Dow crisscross 10,000 over and over again during the next several years!

How can you prepare your portfolio to handle this type of volatility?

Finding Opportunity in the Aftermath

First, prepare for a slow-growth environment in the economy and financial markets over the next few years. And don’t expect unrealistically high returns from your portfolio. Don’t “reach for yield” with investments that appear secure, but may have hidden risks.

Second, don’t expect the old buy-and-hold approaches to work — especially not when it comes to holding index investments. It hasn’t worked over the last 10 years. The broad market index — and the mutual funds and ETFs that track them — could continue bouncing around in a multi-year trading range without delivering much, if any, real upside return over the longer term.

Third, recognize that volatility may be here to stay for several years! Prepare for these up and down markets — and potentially turn this volatility to your advantage by taking a more dynamic approach with at least a portion of your portfolio. Consider making more frequent tactical shifts in your portfolio.

Take advantage of periodic market rallies as they occur, but also watch out for the corrections that may inevitably follow. Be willing to pull the trigger and take shorter-term gains when you have them.

Finally, there are a growing number of specialty funds and ETFs available today that can help you hedge the longer term “core” holdings in your portfolio during a market correction. You may even consider inverse funds to earn potential short-term trading gains, but only with money you have set aside for speculation. After all, these inverse funds can be risky bets and aren’t appropriate for everyone, as we pointed out in Weiss Advice Issue #68.

The bottom line: You’ve got to prepare yourself to live with — and even take advantage of — this kind of market volatility.

This kind of market environment isn’t easy to navigate, but it’s also not the end of the world. It simply presents new challenges that may require a new investment approach.

At Weiss Capital Management, our professional investment strategies are designed to help manage your portfolio in ALL market conditions, including bull markets … bear markets … and yes, even volatile trading-range markets.

Good investing,

Mike Burnick
Director of Research & Client Communications
Weiss Capital Management, Inc.

P.S. Next week, my colleagues and I at Weiss Capital Management will be hosting a special Webinar where we reveal, for the first time, a tactical investment strategy that we’ve developed specifically for today’s volatile markets. Go here now to sign up for this free online event!

^†Weiss Capital Management (an SEC-Registered Investment Adviser) is a separate but affiliated entity of Weiss Research, the publisher of Money and Markets. Both entities are owned by Weiss Group, LLC.

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¹ Chartoftheday.com, 8/27/10

² BondWave Advisors: Weekly Market Summary, 8/30/10

³ Guardian News, 8/10/09; Morgan Stanley Research, 8/10/09

⁴ Ibid.

⁵ Gluskin Sheff Economic Commentary, 8/9/10

⁶ Ibid.

⁷ Bloomberg market data, 8/31/10

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