Surviving the extreme lows of a bear market.

By George Luciani

There is an old axiom on Wall Street: “Buy low, sell high.” That is not as easy as it sounds. In a bear market, however, the corollary also holds true — “Sell high, buy low.”These two strategies are the same, but the mindset is different.

Bear markets are usually defined as a 20 percent drop in the major stock averages like the Dow Jones Industrial Average (DJIA) or the S&P 500 Index (SPX). If an investor waits that long to act, however, it is too late. A self-directed investor would have to study the tenets of fundamental or technical analysis to understand the difference between a normal trading range move and a “reversal”requiring action (buy or sell). For the average investor, this may be difficult to master.

The simplest way to spot a major market change, however, would be to track one of the major indexes like the DJIA or the SPX in a newspaper like Barron’s or The Wall Street Journal that publishes daily charts of the averages. Generally, when the index falls below the 200 Day Moving Average line on the chart, market prices are headed lower for an extended period of time. For 2008, this cross occurred in January.

Had you sold some of your stocks and made more conservative buys like bonds in January, you would have avoided much of the 20 percent decline that followed. If you are conservative, you can wait for the SPX or the DJIA to get back above the 200 Day Moving Average line before reallocating some of your bonds back into stocks. The good news is that bear market cycles are normally followed by four to five years of positive bull market results.

If you are more aggressive, you may need to find an advisor who is tactical and can buy and sell within the bear market cycle for more positive results.

Protecting your portfolio
How proactive you want your advisor to be in making changes to your portfolio in a bear market environment hinges on two crucial factors: Your risk tolerance and the ability of your advisor.

Most advisors are sales people who are directed by their employers to increase their client base rather than manage their existing clients’assets. Portfolios are constructed in a basic asset allocation model that is generally made up of a mix of stocks and bonds according to your risk tolerance. This works fine in a bull market environment, when stocks consistently grow in value, as they did from 1982 to 2000. But what about a period like 2000 to 2003, when the SPX and the DJIA dropped 40 percent and the NASDAQ technology index dropped 80 percent?

An advisor who is truly managing a portfolio makes changes as conditions warrant; not every day or week but as major market reversals occur, especially in the current bear market environment. Unfortunately, most advisors are not sufficiently trained in making those changes as needed. It is up to the investor to question the advisor’s philosophy regarding portfolio changes. 

One caveat: Tactical advisory relationships should only be done under a fee-only arrangement that is void of transaction commissions. If not, excessive commission trading or “churning”may occur. Most advisory firms offer fee-only structures. This type of relationship also avoids any conflicts of interest in any trade made for a client account. 

Tactical asset management is not market timing. Those who make that claim are often attempting to convince you that the (easier for them) buy-and-hold strategy works better in the long run. It does not. During the current bear market that started in 2000 and the previous one, which ran from 1966 to 1982, the major averages made no gain. That’s correct; 16 years with no gain. Since 2000, the SPX is well below its current value. How long this current bear market will last is unknown. Sitting back, holding and losing money, however, is not the answer.