Profiting in a Bear Market

Nov 5, 2014   //   by Profitly   //   Market, Profitly  //  Comments Off on Profiting in a Bear Market


Give us an S&P500 down more than two percent last week and the Dow Jones once again wiping out all of its gains for the year, and you’re bound to get more people talking about the end of the bull market.

In his post titled, “Signs of a Bull Market Turning Bear,” Barry Ritholtz lays out some startling facts.

• This bull market is now more than 5 1/2 years old;

• The Standard & Poor’s 500 Index hasn’t had a 10 percent pullback since October 2011;

• Small-cap stocks as measured by the Russell 2000 have fallen below their 200-day moving average for the first time since November 2012;

• Almost half of Nasdaq stocks are down 20 percent from their one-year highs, meaning they are already in a bear market;

• U.S. markets are down 3 percent from all-time highs;

Thursday’s sell off was of particular concern. The Dow was down more than 300 points. To say the bulls are worried would be a fair statement. Ten of the past 12 trading sessions saw swings of 100 points or more in the DJIA.

Why the sudden volatility? Ebola, slowing global growth, a strong dollar, the end of quantitative easing, and the beginning of earnings season.

“The list of worries ranges from the strengthening dollar’s harm to U.S. earnings, the end of quantitative easing, Europe’s weakening economy and the International Monetary Fund’s reduced forecast for global growth. I am far less certain that those headlines are anything more than the excuses for the selloff, rather than the cause,” Riholtz says.

So how do you trade stocks from here? For those looking at the general market and not penny stocks, “one of the best ways to identify a market that is exhausted is to look for divergences between Breadth (i.e. the number of advancing equities versus the number of declining ones) and Price (i.e. new highs). That is a concept that Paul Desmond of Lowry Research has researched and written about many times over the years,” Ritholtz says.

He goes on to say that so far, each side in the bull-bear debate has been quick to declare victory. Doug Kass of Seabreeze Partners has been calling this “The Ali Blah Blah Top,” suggesting that the Chinese tech company’s monster initial public offering is a signal that markets have gotten too frothy. He notes that he won’t be initiating any new long positions “unless share prices drop meaningfully.”

He notes that the flip side of the argument comes from bulls such as Holland & Co. Chairman Michael Holland. He suggests that the easy part of the bull market, driven in part by the Federal Reserve, is ending: “The training wheels are coming off, the lack of volatility is ending, the ‘New Normal’ is ending, and the ‘True Normal’ is returning to markets.”

As penny stock traders know the best, things can turn quickly and you need to be ready to act at the drop of a hat. “What looks like a strong bull market on the surface, but with weak internals, can easily slip into a 10 percent correction,” Ritholtz says.

His ends by saying his belief is that 2014 may be a year of consolidation and digestion, as markets in 2013 got way ahead of both the economy and earnings.

Our gurus do pay attention to broader trends, but since they focus on specific stocks, they are able to make a profit in both bull and bear markets.

For instance, in the past 30 days, the DJIA is down about 3%, meaning if you would have invested $100,000 in the Dow one month ago, it would now be worth $97,000. On the other hand, Superman is up a whopping $404,016 in that time frame, Tim is up $60,092, and Investors Live is up $34,905.

It’s easy to tell where the money is to be made. Sure you have years like 2013 where the S&P500 is up more than 30%, but that is far from the norm. The 10-year average return for an S&P Index fund is just 7%, according to Morningstar.