Thursday, January 31, 2008

Bear market?

Buying on dips hasn't worked lately. That's a sign of caution. Case in point: My tip to buy Asia (Dec. 29 '07 post) was dead wrong. Recent leaders--foreign and large cap growth stocks—have underperformed during recent sell-offs, as well as during rallies. Meanwhile, what was down is up: Losing groups like financials (IYF) and REITs (IYR) have rebounded lately. But these rallies look like attempts at bottom fishing. Yes, the rallies in some downtrodden groups look strong over the last week. If you believe all the bad news in banking and real estate is out, that the stocks are pricing it all in, go for it. Just be prepared to be wrong.

Where else to invest? Good question. Every style and sector is now in a downtrend; there is no leadership. Use the rallies that are likely to sprout as a chance to lighten up on stocks. Treasury bonds have relative strength ratings of 90 from IBD. GSG is a buy for commodity exposure. IGE and IYM have perked up—that might indicate energy and materials remain a good place. IAU and SLV for gold and silver (but wait for a correction). UDN for a play on the falling dollar. But even as a whole, these ETFs do not make a complete portfolio. With a new account today, we'd be heavy on cash and Treasuries.

We could be wrong about our bearishness. (Obviously, it wouldn't be the first time.) We're following the crowd here, which is typically wrong. The pain and anxiety being felt currently is often the sign of a buying opportunity.

But we'd bet it's just a short-term buying opportunity. The volatility in the market now is a sign to be careful. We're likely in a bear market. It's probably a time to lighten up on equity market exposure, which we have been doing over the past several months in both model and real-money accounts. (Swap similar ETFs or move to cash/Treasuries for tax losses) The severity of the correction that has taken every heretofore strong style and sector down below 200-day moving average lines and left them there with no strong rebound, together with the attendant bad economic news, points to a possibly severe downturn.

This is not a call to panic. But the red lights are flashing.