`I dare you to cross this line,” Bugs Bunny says to Yosemite Sam, an instant before the cartoon villain defiantly steps across.
“Now, this one.”
“That one.”
Each time, the line is crossed.
It’s akin to the warnings issued by stock market bears over the last few years. Some bears started calling for an end to the current bull market back in 1990, warning investors that the time had come to get into cash. The calls got louder after the up year in 1993 and became a chorus after a flat year in 1994.
By early 1995, some experts were forecasting doomsday, and the market went bang-zoom-to-the-moon without them.
In the cartoon, in case you have forgotten, Yosemite Sam crosses all the lines until he walks off a cliff.
So here we are nearing the end of 1996, and the bears are out in force again. This time, they see a downturn as likely after the presidential election in November. Having survived a summer selloff and roller-coaster third quarter, bears believe the market surely is headed for a dive at year’s end when the election is no longer an excuse for the Federal Reserve Board to hold down interest rates.
Between the gloomy forecasts, the election and the market’s longest period ever without a bear market, a lot of ordinary investors are wondering if this will be the time when their portfolio crosses one line too many and tumbles off the cliff.
The choices boil down to stopping or stepping forward again, albeit possibly with a bit more caution.
For most investors, the answer is to keep walking. Instead of developing a unique strategy for a bear market, most experts suggest following a strategy aimed at your long-term goals.
Remember that while Yosemite Sam takes a powder, he does get up to fight the rabbit again.
“Having a bear market strategy means you are playing a loser’s game,” says Kurt Brouwer of the San Francisco money management firm Brouwer & Janachowski. “Plenty of people have been ready and prepared for a bear market for six years, and it hasn’t happened. In the meantime, they were so worried about losing money during the downturn that they lost by not participating in one of the biggest increases in history.”
People who try to avoid bear markets sometimes get mauled. Witness the so-called bear-market funds, designed to prosper when the rest of the market panics.
Two well-known current examples are the Prudent Bear Fund and Rydex Ursa. The former is down 11 percent since it opened last year; only three stock funds have done worse. Ursa, meanwhile, is designed to perform inverse to the Standard & Poor’s 500, so it has lost more than 7 percent this year despite the market’s lurching moves forward.
Another way investors hedge the market is to add funds that typically rise when the economy sags, notably gold funds. Through September, the Lipper Gold Fund index is up about 11.5 percent this year, a return just a hair better than the typical growth fund. Over longer periods, however, gold funds tend to be more volatile and provide a lower return.
“If you start to change your portfolio dramatically based on current conditions, you can justify it as trying to stay on track for long-term goals, but the truth is that you have taken a short-term view,” says Marc O’Brien of O’Brien Management Inc. in Cambridge, Mass. “Downturns are a good time to review your holdings, but a bad time to give up on your strategy.”
If you make moves anticipating a market decline, you should also expect a rebound and you should position yourself for that, too.
As a result, most experts say that the average investor should get loaded for bear by considering minor asset allocation adjustments, typically with money that is about to go into funds rather than moving money already in place.
There is no such thing as a bear-proof portfolio, but here is some fine-tuning that might protect you in a downturn:
– Focus on assets that have done well in previous bear markets. Growth-and-income, equity-income and balanced funds are less risky than pure growth funds and aggressive-growth choices.
– Hold more in cash. This is not about market timing, it’s about your short-term needs. If you need the money within five years, it may be time to consider a money market account.
Being greedy is one of the easiest ways to lose money. If you have “don’t-mess-it-up money” earmarked for, say college tuition or a new car or other short-term needs, don’t put it at risk. If the market were to decline 20 percent next year, you would need two years with more than 10 percent growth just to get back to break even; if you can’t afford that kind of risk, be safe.
– Get some international exposure. Your fund managers may already be doing this (many stock funds purchase international issues) so examine your fund’s current asset allocation to be sure you don’t overload your portfolio with foreign issues.
– Look for “value” funds. This is a stock selection issue, but value funds seek underpriced issues, while growth funds want companies with improving earnings. Because that’s tough to find in a bear market, growth funds can be in for rough sledding. Value funds will falter too, but the ride will be smoother.
– Pick funds with a low “beta.” Beta is a statistical measure of volatility in comparison to the S&P 500. Funds with a beta of 1.0 tend to rise and fall in value by whatever amount the index is moving. A fund with a beta of 1.1 will have swings 10 percent wider than the S&P, making them more aggressive choices for bullish investors, while funds with a beta of less than 1.0 will rise or fall less than the index.
Most rating services disclose a fund’s beta, but most funds will provide the data if asked for it. Remember, too, that a fund’s beta changes as the manager alters the portfolio, so get up-to-date numbers when you reconsider your holdings.
“The idea in getting ready for a bear market is to make risk allocation decisions,” says James Stack, editor of the Investech newsletter. “The time to review your portfolio and to see how comfortable with the risks you are taking is before the market goes down. You may decide to keep going full speed ahead, but you should at least review your holdings to make sure that a bear market will be bearable.”
