How to Play the Transition From Bear to Bull
April 10, 2008 – by Richard Band
The mercury is climbing, the blossoms are bursting—so when will Wall Street finally celebrate a springtime of its own?
For eight long months now, a ferocious credit crunch, unprecedented since the Great Depression, has trapped investors in a deep freeze. Not only stocks and real estate, but even some of the (reputedly) safest bonds and money market instruments fell victim to the Arctic blast.
Happily though, I’m detecting hints, here and there, of a thaw. It’s taking a lot longer than I had hoped, but we will see the end of this new Ice Age. As a balmier climate sets in, we can look forward to healthy markets again—a return to the steady, consistent profits we enjoyed from 2003 to around mid-2007.
Let me show you what’s behind my optimism and how soon the improvement is likely to begin. I’ll also map out a three-point strategy that will give your portfolio the stamina to survive—and thrive—even if the markets should remain chilly a while longer.
Listening to Mr. Market
A careful reading of the economic evidence leads me to believe that we are well past the midpoint of the credit crunch and related disruptions in our economy. Good times are coming! Two indicators in particular lead me to this conclusion:
#1: Massive cash reserves are building up in money market funds.
At last glance, investors have poured $3.4 trillion into money funds—the traditional parking spot for cash awaiting investment in the stock market.
How significant is this number? Let me put it in perspective for you:
As a percent of the total market value of the Standard & Poor’s 500 index, money market fund assets now stand at virtually the same level as they did at two historic stock market bottoms: in August 1982, when the great Reagan bull market began; and in March 2003, when the first bull market of the new millennium lifted off.
What this means to investors today: There’s definitely enough fuel here for an explosive stock market rise as soon as a trickle of good news begins to coax investors off the sidelines. With money market yields dropping like a stone, the pressure to put cash to work at higher returns will prove irresistible.
#2: Buyers have already started to flex their muscles on Wall Street in recent weeks.
Normally, within a few sessions after a major stock market fall, investors are treated to at least one “power day.” This is when the number of shares traded in stocks with an advancing price overwhelms volume in declining stocks by at least a 9:1 margin in the NYSE.
Now, throughout January and February we didn’t see one single power day. But then, two occurred in the span of one week: on March 11 and the 18.
Power days don’t guarantee that the final market low is behind us. However, this latest duo, coming just before and just after the Federal Reserve defused the Bear Stearns bomb, may actually suggest that Wall Street is seeing the end of the credit squeeze.
As the signs grow stronger, a new bull market will take hold, propelling the blue chip indexes to record highs by late 2008 or early 2009.
Your Three-Part Action Plan for Dealing With This Tricky Transition
Make no mistake, we’re still in a grey area here. That’s why it’s vitally important to tread carefully. Here’s what I suggest investors do now:
1. Get fully invested in stocks (up to your personal limit).
Last month, I advised my Profitable Investing readers to wait for a drop in the S&P 500 to 1,310 or less before accelerating their stock purchases.
That turned out to be a good tactic, because the market fell sharply in late February and early March, holding well below 1,310 for most of the stretch from March 6 to the middle of the month.
Now that we’ve had two power days, the risk of a runaway move to the downside has diminishedmarkedly. Investors should act promptly and deliberately to wrap up your stock purchases over the next few weeks. Any daily decline of 1% or morein the S&P should spur you to do some buying.
2. Invest in mutual funds and exchange-traded funds for the immediate future.
If I’m correct that a new bull market is about to emerge (with several years of staying power) then investors have found themselves standing at that rare juncture where picking the “right” stocks is less important than just being in the market.
As in early 2003, when the stock market was in a similar position, I recommended that my Profitable Investing subscribers invest most of their new money into index funds, which cast the widest possible net.
Large-cap growth stocks have outperformed large-cap value stocks since last June, and small caps of all stripes by an even wider margin. While that leadership will eventually change, it will probably continue for at least the first six to 12 months of the next bull market.
3. Maintain adequate reserves of cash and CDs (or short-term bonds).
Balance is essential in a dangerous world. I’m an eternal optimist, but I also believe in preserving capital. Therefore, always keep enough cash on hand to protect yourself from the reckless U-turns of Mr. Market! I’m currently recommending that my Profitable Investing subscribers open an account with this Internet-based bank. It has a generous 3.87% yield, including daily compounding. Deposits of $50,000 and up earn even more. And, unlike others, it allows you to write checks against your account. You can find its name in the April issue by clicking here.
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