My Diary 411 --- Surviving in the Bear Market

Surviving in the Bear Market (July 24, 2008)

Key Points

Ø         Bear Market phase II due to global slowdown may be in its earlier stage

Ø         Buy Low Sell High means thinking ahead and be patient in bear market

Ø         Save the capital and survive for another day, risk management is the key

1)                Bear Market phase II is in its earlier stage

Although we saw several furious short-term rallies recently, the market has entered official bear market territory (>20% drop) earlier this month with Canada the only exception. I think the bear market phase I (Credit/Financial sector related) has come to an end due to the capitulation response caused by the US government’s “bail-out” action of F&F as well as the SEC’s call on naked-short selling. Bear market phase II (Inflation/ Growth related) may still in its earlier stage, featured by a global slowdown underpinned by deflationary DMs and inflationary EMs. The only engine of global growth left now is Asia or largely China, but there are worrisome signs, including high inflation and the lag-behind central banks.

Ø    The whole commodities complex dropped further indicating growth slowdown ahead: Crude pulls back to 124/bbl, Gas stockpiles rose MTE; Gold -2.7% @ $922.80, biggest drop in 6W;Silver -3%;Copper -1%(@ a 1M low, as well as soft commodities (-7%).

Ø     Global inflation reached an 11.5 year high of 4.9% yoy in June and central bankers are more hawkishly inclined everywhere, even in US. In Asia, inflation is a real threat as 1) food and energy are bigger CPI component; 2) Asia is still growing; 3) Asian central banks continue to maintain a loose monetary policy

Ø     US market seemed dominating by persistent toxic themes -- banks exploding higher and resources underperforming. This is because the initial growth downgrade is beneficial to stocks through inflation-destruction. But growth may dropped further and here is the new signal --- BBG: Japan’s exports unexpectedly fell (+1.7% vs 3.3% estimate) for the first time in +4 years in June, led by a drop in demand in US and Europe

2) Buy Low Sell High means thinking ahead and be patient in bear market

Everybody knows that one should buy low and sell high. But my recent interpretation in the bear market is 1) bear markets give me a chance to buy low; 2) bull markets give me a chance to sell high. Unfortunately, there are a lot of investors are lulled into complacency during bull markets and scared out of their wits in bear markets. I feel that to be a good trader is like a chess player that one should think a few moves ahead. Yes, the market has fallen sharply over the past nine months, bt it may fall further in the weeks ahead. Thus the longer the bear market lasts, the better off one will be The key is no one when can tell me when the next bull market will begin, how long it will last, or how high the market will ultimately go. Thus, just be patient in the bear markets.

Ø   John Paulson, the money manager whose bet against the US housing market helped him earn an estimated $3.7bn last year (Sell High), is starting a hedge fund to provide capital to financial firms (Buy Low) hurt by mortgage write downs.

Ø   Historically, in the last long bear market, 1969 to 1982, stocks returned just 5.6% annually. But later it gave investors up for an 18-year bull market where stocks compounded at 18.5% a year.

Ø    US stock is undeniably cheap, selling at just below 15XFWPE. That's the cheapest the stock market has been since 1991. Taking any 10-year rolling period and stocks outperformed approximately 80% of the time.

3) Save the capital and survive for another day, risk management is the key

My another lesson learned is that the biggest difference of a trader from a portfolio manager is you have to survive for another day rather than another year or a full cycle. Since market volatility is both your dearest friend and the most hated enemy, risk management is the single most important thing for an investor, even for a team of talent like LTCM. Moreover, for a trader, the most important thing to be bear in mind is to be prepared for your downside and to be self-disciplined as Mr. Market is never predictable
.

Ø   Warren Buffett has two rules. The first is "never lose money." The second is "Don't forget Rule Number one."

Ø    George Soros (1995): looked at markets as a casino where people act as gamblers and where their behavior can be understood by studying gamblers. He regularly made small amounts of money trading on that theory. There was a flaw in his approach, however. If there is a…tide...he can be seriously hurt because he doesn’t have a proper fail-safe mechanism.”

Ø     Philip Anderson (Nobel Prize Recipient, Physics); Much of the real world is controlled as much by the ‘tails’ of distributions as by means or averages: by the exceptional, not the mean; by the catastrophe, not the steady drip; by the very rich, not the ‘middle class.’ We need to free ourselves from ‘average’ thinking.

(The End)