Bear Market Buying Debunked

http://community.marketsmith.com/telligent/b/blogs/archive/2011/09/29/8097.aspx

The hardest part for investors sitting out during a market correction is their conflicted thoughts about missing potential opportunities. They fear the market will leave them behind, or they want to get back in early. But the impulse to make money by fighting the market’s trend can be costly. In a bear market, two of the biggest temptations for such investors are 1) Dividend-paying stocks (especially in the Dow) and 2) the continued fundamental strength of the prior cycle’s leading stocks. The excessive risk in this environment makes gains on long positions doubtful, but these two “potential opportunities” have even clearer flaws.

First, the problem with dividend stocks in poor market environments is that price depreciation can wipe out gains made from the dividends. See the net losses on the top 7 well known dividend paying stocks in the table below.

	Dividend Yield	Relative Strength Rating	Price Chg YTD	Net Gain/Loss
FTR	12.3	26	-37.00	-24.70
LEG	5.6	49	-11.29	-5.69
HPQ	2.0	10	-43.97	-41.97
DD	4.0	38	- 15.28	-11.28
GE	3.8	47	-15.53	-11.73
CAT	2.5	32	-17.07	-14.57
CSCO	1.5	61	- 20.80	-19.30
KFT	3.4	88	8.63	12.03
MCD	3.2	92	14.68	17.48
IBM	1.7	94	20.98	22.68

Relative Strength (RS Rating) is usually more relevant to overall gains in stocks than dividend yields (KFT, MCD and IBM in the table above). If you have to own dividend paying stocks now, the high RS stocks are the ones you want to own, because by definition they are holding up the best. If you are tempted to buy solely because the dividend looks attractive, you may be taking on more risk than you realize. Remember a position in cash isn’t yielding anything, but at least you are not going backwards.

The other temptation stems from the fact that the fundamental stories that propelled the leading growth stocks of the last bull cycle are still intact. “Buy them now while they are cheaper” has been said about stocks like GMCR, CMG, PCLN, LULU, and AAPL. While the fundamentals continue to be impressive for these leaders, the problem with buying them now is that you are guessing that the market has bottomed here. Without confirming that a new uptrend has begun by consulting your stock charts, these stocks and the market could very well continue lower.

To soften the severity of the market’s weakness, many would like to write off the action of the leading stocks as simply “an overreaction by momentum stocks.” But why all of a sudden are these stocks being labeled as “momentum”? Investors should recognize that these stocks are some of the leading growth stocks since the market uptrend began in March of 2009. All have formed late stage bases and are vulnerable to topping. Most breakouts have failed and have, or are about to undercut the lows of their most recent base. In the end, strong fundamentals are not enough to fend off the topping cycle all stocks eventually go through. From our decades of studying the behavior of leading stocks, we know that leading growth stocks will correct, on average, 72% from peak to trough. We also know that only 12% will recover and reassert themselves in the next bull cycle. But more importantly, we know that those leaders are an indicator for where the market is probably going next. And right now, there is a higher probability that we are heading lower.

Even AAPL, with some of the best fundamentals out there, will probably get hit if the market keeps sliding lower. Don’t get me wrong, I love AAPL. I own a Mac, an iPad, an iPhone, and an iTunes library full of music. But when the tide drops, it lowers all boats—even that beautiful yacht that everyone wishes was theirs. Admittedly, there may be one to two stocks, or and industry group, that rises during a bear market. But the risk you will take on, and the losses you will incur on the other stocks you buy in trying the find “the one,” will most likely make the entire endeavor of buying stocks unprofitable (until a new market uptrend has begun).

I can even talk up a stock like BIDU, but the same fact still applies. The stock gapped down through its 200-day moving average, and after today (9/29) is now another 10% lower. At least for now, the stock has topped. There is a one in eight chance that it consolidates the price depreciation and sets up to go again in the next bull market. So for now all you can do is sit and watch. Maybe it will, maybe it won’t.

A good example of a terrible stock to be tempted to buy right now is NFLX. Unlike the other leaders mentioned above, this one has had a major negative change to its fundamental story over the last few months. However it continues to be a topic of discussion among investors now because of its merger/partnership rumors with companies like AMZN or Facebook, or content deals with companies like DWA. Given the huge risk in this market and in this stock in particular, why would anyone place a bet on a single event that may or may not occur? That isn’t investing, it’s gambling.

Hopefully most investors won’t have to sift through the endless options and “debunk” each opportunity that comes along while the market is in this correction. The fact that the trend is down should be enough to keep them out.