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Its not a bear returning to haunt us from the depth of the 1930s when my father was a broker on Wall Street. Nor is it one of the seasonal bears that used to periodically visit when I was starting my own career in the 1970s. This is the apparently tame but potentially wild animal that was born in the Internet bust of 2000 … grew into the tech wreck of 2001-2002 … and may now be returning to take on the S&P and the Dow. But this bear is more than just a stock-market beast that can eat away at your investment portfolio. Its also coming with a major change in the climate for your investment real estate, your home, your business and job your entire financial future. Today, I will tell you what I think you should do if you agree with me. Plus, Ill also tell you what alternatives you have even if you dont agree with me. Wheres The Bear? You can see the bear lurking at Delphi Corporation, which, despite a massive bankruptcy filing just two weeks ago, is now being threatened by an equally massive labor strike. You can see it at General Motors, which, despite a flurry of optimism sparked by its landmark deal with the UAW this week, is already beginning to suffer a new decline in its shares. You can see it at Ford, where the latest $284 million in losses, although smaller than GMs, have now thrown all of Detroit into a state of panic. You can see the bear in home construction, in home lending, and in homes themselves. You can see it spreading to some insurance and banking stocks … going back to technology … even spooking some investors in energy and natural resources.
Just three weeks ago, the S&P 500 Index suffered a critical breakdown, falling below an upward trend which had endured for over two and a half years. And Im not just talking about a line on a chart. This trend also represents the rally in the stock market and the recovery in the economy which began in the spring of 2003. But now this trend seems to be breaking down, ushering in a new phase in our current history. Indeed, if the S&P falls to its next support level, it could reach the 950 – 1000 area. This may take some time. And there are bound to be exceptional situations that hold up relatively well. But unprepared investors that take no action today are bound to regret it.
What to Do If You Follow these steps: Step 1. Start by unloading the most vulnerable stocks you own, such as those receiving a C grade or lower from Weiss Ratings. You can get the ratings at our website, www.WeissWatchdog.com and you will also get e-mail alerts whenever the ratings change. Just remember that the Weiss ratings are market neutral. In other words, they reflect our analysts objective evaluation of each individual company and each individual stock not one persons bearish or bullish opinion. Step 2. Consider paring down your holdings in the higher-rated stocks as well, especially those in the most vulnerable sectors. Remember: In the 2003 bull market, even some of the worst stocks went up. Likewise, if the bear is returning, even some of the best can go down. Step 3. Long-term bonds, normally a safe haven in times like these, are also likely to go down quite sharply in value. Reason: This face of the bear is marked by rising interest rates, which automatically drive down the value of all long-term bonds. And we may not see the other face of the bear accompanied by lower interest rates for quite some time. So get out of long-term bonds now. Step 4. If you feel youre overloaded, reduce your exposure to oil and gold stocks. I have not changed my mind about the bull market in natural resources, nor has Larry changed his. But investors often throw out the baby with the bath water, selling the good stocks with the bad. If thats their pattern this time too, even natural resource stocks could fall somewhat further. Then, get ready to jump back in at the right time. Step 5. Build cash. Most people dont consider cash an investment. I disagree, especially if you put the cash into something that brings a steadily rising return. Example: Treasury bills or a Treasury-only money fund like:
Step 6. Wait patiently before returning to traditional stock-market investments. This bear is in no hurry to come and in no hurry to leave. Step 7. Learn all you can about non-traditional investments. There are two broad categories: (a) Investments that can go up DESPITE a decline in most stocks. If you explore the first category, youll find a surprisingly wide diversity of investments that have little or no correlation to stock market bulls or bears: Gold and silver, oil and gas, euros and reals, even interest rates themselves. My staff and I devote a lot of time to these because we want you to always be able to find investments that are going up, regardless of the stock market. (See, for example, our latest free reports on (a) gold, (b) oil and (c) interest rates.) Step 8. If you have hired investment advisers, be sure to consult with What to Do Even If You Of course, you could ignore all of this and just make believe everything is business as usual. You could ignore autos and housing, the two largest industries in America, dont matter anymore. You could deny that inflation is surging, that interest rates are rising or that both are powerful bear market forces. Indeed, if youre in denial, you have plenty of company, including some of the most respected analysts on Wall Street. Like them, you can defy the gravity of the situation, make no changes in your plan, and even get some kudos from family and friends for your bravado. But you can also lose a lot of money. My philosophy: If you want to disagree with me, thats entirely your choice. It doesnt make you wrong or me smarter. It could even be the opposite. But I think wed both be pretty dumb if we didnt recognize the real possibility of each others scenario. That means taking out some protection a net to fall back on just in case the trapeze does snap … Step 1. Evaluate your stock portfolio. Is it almost entirely tech stocks? Or is it mostly blue chips and other stocks, with just a sprinkling of techs? If you have a large portfolio of blue chips and other stocks, consider moving a portion of your money into the shares of a mutual fund thats designed to go up when the stock market falls. For example, the Rydex Ursa fund (RYURX) is modeled to rise about 10% for every 10% decline in the S&P 500 Index. When you hold its shares, the more the S&P falls, the more you make, helping to offset losses in your stock portfolio.
In July, for example, while the S&P rose, Rydex Ursa fell. But now, with the S&P falling, Rydex Ursa is rising accordingly. If you have it in your portfolio, youll be very happy that at least one of your investments is riding with the bear and not against it. (Ursa is Latin for bear.) Step 2. Estimate your risk of loss. No one knows for sure how much or how quickly the market could decline. But a simple rule of thumb is to take the current value of your portfolio and give it a 50% haircut. If your portfolio is worth about $100,000, your risk of loss, in this scenario, is $50,000. If you have $50,000, your risk is $25,000, and so on. Step 3. Decide how much of that risk you want to protect yourself against. If you wanted protection for the entire amount, youd have to invest about dollar for dollar in a bear funds like the one I just told you about. But most people prefer to buy only partial protection to cover, say, about half of their portfolio. Step 4. Raise the funds for your crash protection program. Where do you get that extra money? You could take it from your cash assets. But if you did, youd be moving money from a safe investment (such as a money market fund) to a much more aggressive investment. Thats not very prudent. So, my recommendation is to liquidate enough from your stock portfolio to finance this program. Say you have $100,000 of stocks in your portfolio. You dont have to liquidate $50,000 worth of shares to raise the money. Youd only have to liquidate $33,333. The reason is that after you liquidate the shares, you will only need to protect the remaining $66,667 in your stock portfolio. Then, the $33,333 is the amount you need to cover half your portfolio risk. So the formula is simple: If you want a program that will protect you against half your risk, and you dont want to take money from another source, you should liquidate about one-third of your shares to generate the money. Cheap Bear Insurance If you feel you cannot afford to reallocate assets to a bear fund, a cheaper way to protect yourself from a market decline is to take out some bear insurance. Im not talking about a policy you buy from an insurance company. But the principle is very similar: You pay a premium which covers a specific period of time, anywhere from just a couple of months to as much as two years. If the bear comes during that period, you can get a payoff which may double, triple, and possibly grow as much as five or ten times the premium you paid, depending on the timing, speed and depth of the decline. If the bear does not come, you lose the entire premium you paid no refunds. But you can never lose a dime more. Since the entire premium can be lost, this is obviously not a program for all of your money not even half or a quarter of your money. But it is something to consider for a portion of your money as a hedge against a potentially vulnerable stock portfolio. Step 1. Learn about put options investments that give you the opportunity but not the obligation to sell a stock and profit from its decline. Step 2. Understand the advantages and disadvantages of stock options: Advantage #1. When you buy stock options, you can never lose more than you invest. Unlike futures or other speculative investments, no matter what happens, you are 100% protected from losses that exceed your initial investment. You can never get a margin call. Advantage #2. On average, you can get more leverage from options than you can with a mutual fund. The fund I mentioned, for example, is designed to give you a 10% return for every 10% decline in the market. With put options, you could make 50% or even 100% from a 10% market decline, depending on the market conditions. Advantage #3. You can invest in options with less money, sometimes such as $100 or $200 plus commissions. Warning: If you are investing a substantial portion of your savings in options, you are probably taking excessive risk. The main rule of all options investing: Never invest more than you can afford to risk. Now for the disadvantages Disadvantage #1. More leverage is a double-edged sword. If your put option makes you a 100% profit on a 10% decline, it means you could also wind up with nearly a wipeout loss if the market rises 10%. Disadvantage #2. Unlike mutual fund shares, all options have an expiration date. This means the market decline needs to take place before they expire. Disadvantage #3. Just as an insurance policy has a deductible, all options have a strike price the price level at which the option really begins to work for you. Disadvantage #4. If theyre short term, put options can be very volatile and should be watched daily, even hourly. But long-term options, called LEAPS, are more manageable. Sharp Correction in XLE Drives Heres a very current example. Just this month, when energy stocks took their first significant fall, we recommended that you consider lightening up. Plus, as another alternative, we recommended you look into put options on the most actively traded ETF in the energy sector the Energy Select SPDR (XLE).
Now, the XLE has suffered a pretty big correction. And based on a quick look at its chart, we figure it has some more room to fall, without any change in the long-term bullish outlook for energy. If youve got energy stocks, this may be bearable, but its not pleasant. It would be a lot more bearable, however, if you held the XLE put options. As long as the XLE was soaring, those put options were sinking. But now, with the XLE sinking, many of those options are going through the roof. One very cheap XLE put option, for example, out of the money and with a nearby expiration, was selling for practically nothing at the beginning of October just a few weeks ago. Yesterday, you could have sold it for $2.50. So depending on when you bought it, your profit on the option could have been anywhere from 100% to 1000%. Of course, thats easy to see or say with 20-20 hindsight. Actually picking the right options at the right time is not nearly as easy. But given the fact that you can never lose more than you invest, they can be cheap bear insurance. (For detailed instructions on bear market funds and put options, subscribe to my Safe Money Report and I will send you my complete report, Crash Insurance as one of your free bonus reports. Or, call us at 800-236-0407).
One Last Thought
And although persistent, its not necessarily malevolent. It can give you the opportunity to pick up bargains in great, undervalued companies when it comes. And it can pave the way for a wholesome economic recovery when its gone. Good luck and God bless! Martin
About MONEY AND MARKETS MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Marie Albin, John Burke, Michael Burnick, Beth Cain, Amber Dakar, Scot Galvin, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others. 2005 by Weiss Research, Inc. All rights reserved. |
The New, Old Bear
Theres a bear in our midst. 
If you know where to sniff, you can also smell the bear in the charts. 
Of course, it also works in reverse if the S&P appreciates 10%, the Rydex Ursa fund will likely depreciate about 10%. 
Although it may often remind you of bears the last century, the bear in our midst today is a uniquely 21st-century animal.Previous post: Three Warnings Coming True
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