5 Strategies for Investing Properly, Cautiously, and Intelligently in This Bear Market

The following is a guest post from Stephen T. McClellan, author of Full of Bull (Updated Edition): Unscramble Wall Street Doubletalk to Protect and Build Your Portfolio.

This is a perilous period in the stock market; a deceptive bear market that disguises its downward drift. Beware of misleading Wall Street doubletalk, as it tempts investors into this dangerous bear market. The Street tends to discourage and even hinder proper investing. Its advice is unreliable and often contradictory. Professional insiders know better than to take the Street literally. To be an astute investor you must fathom the puzzling, strange, ambiguous ways of Wall Street that it would prefer to keep secret. Be a cautious, realistic, long-term investor. Preserving capital is paramount -- the most important investment strategy that I emphasize in Full of Bull. Entering this bear market is a risky strategy.

1. Keep Short Term Influences at Bay

The Street wants you to pay attention and generate commission trades on a regular basis, to create business. That is why it regularly alters stock opinion ratings and is always so optimistic. Brokers market stocks, analysts recommend stocks. They are not objective advisors. The investment world evolves around the exceedingly short-term trading mentality of Wall Street. So too the media. TV stock market programs need you to tune in everyday, every hour, to collect advertising dollars. The message had better be new and different every time you switch it on, to keep you interested. It is all about drama, ideas, news, and color to engage you. Companies and executives are similarly short-term focused. Their emphasis is on current quarter earnings results and managing Street and investor expectations low enough to "beat" the consensus. Keep these subjective short-term influences at bay. Put them in perspective. Pay some attention but do not let them be a consuming distraction.

2. Steer around confusing Wall Street gibberish. 

A Wall Street Journal headline recently declared, "AIG Corrects . . . " Given the Street's eternal optimism and favorable bias, it uses the term "correction" to indicate a stock-price decline. I always viewed this as absurd since the Street never labels a stock-price rise as a "mistake." Thus, I assumed the article pertained to the dive in the AIG stock. What a surprise. It was referring instead to a 24% rally in the shares and described "what analysts said was a partial correction from the stock's sharp decline in the first four days of the week." This is an ultimate example of the baffling Street terminology and guidance. You need to cut through this malarkey, correctly interpret Wall Street commentary and opinions, and avoid the pitfalls of inappropriate research guidance. Step back, think, ponder, observe, and take an intelligent approach to investing.

3. Understand that being wrong is part of the process.

A Wall Street pioneer and renowned investment consultant, Peter L. Bernstein, who passed away recently, lived through the boom and bust of the 1920s and had a 70-year career as a Street portfolio manager. When asked what was the most important lesson gleaned during his seven decade run, he was emphatic -- the idea that " You can figure this thing out. You have to understand that being wrong is part of the [investing] process." His approach was always to consider the consequences if the investment decision is wrong. His strategy was to take big risks only with small amounts of capital, and only take small risks with big amounts of money. Investors must avoid incurring whopping losses. Have the discipline to reassess if a holding declines by some 20%. The economic and stock market outlooks are ominous. Investors should take a guarded stance.

4. Know that bear markets regularly tempt investors to wade back in.

During bear markets, each time there is a precipitous drop, it is followed by a modest recovery, masking as the beginning of a new bull market. Do not be deceived into believing that such bear market rallies are the outset of a new bull phase. Alan Abelson pointed out in Barron's that the new buzz word on the Street was "exit strategy," as the market faded following the March-April bear market rally. His view is that investors could have avoided this necessity with better foresight, that is, with an appropriate "entry strategy."

5. Beware of dead-cat bounces. 

Even a dead cat will bounce if it falls far and fast enough. Any stock or market that drops similarly will experience a rebound at some point. After single-digit declines four quarters in a row, the stock market nosedive worsened to double-digits in the fourth quarter last year and again in the first quarter earlier this year. So a spring back in the second quarter was a reasonable occurrence. But it was hardly the beginning of a sustained recovery. The market could still easily plummet by at least 10% as the bear market endures. A reasoned, conservative investment approach precludes jumping into stocks given the hazardous conditions. However, this is not the counsel you will hear from Wall Street.

Use Wall Street's information and research content, not its conclusions or recommendations. Do not be fooled by the Street. Successful, long-term investors focus keenly on investment entrance strategy and conservative management of capital. It is not what you make, it is what you keep. The Street pays little heed to risk, the possibility of permanent loss of capital, in the pursuit of big gains. But an intelligent investor should seek consistency rather than outsize gains, and always pay attention to protection of capital, especially in these precarious times.

Comments

[The Dividend GUy]

I think that much of what Stephen writes concerns setting up a proper asset allocation - with the right asset allocation in place for your profile (and the willingness to stick with it), investors will be much better positions to overcome and not let the issue discussed at bay.

[MrAtoZ]

So regarding #5, I'm curious...does the author regard the 42% (DJIA) or 58% (Nasdaq) rises since early March as dead cat bounces? There's likely a good case now that the cat carcass has bounced too high, too fast since the end of winter, but on the other hand, there has been a shift in sentiment, and my guess is a signficant portion of investors who capitulated during the winter and went to virtually all cash or bonds are now kicking themselves for missing the bull market of the past five months, just as I kick myself for not reducing my stock exposure in Oct. 2007 when the market peaked. But even with the losses I incurred between 10/07 and 2/09, I didn't completely cash out, and now - at least as of today, knock on wood - have enjoyed a healthy rebound in my portfolio.
My point is, this article seems as dated as an Edwards for President campaign flyer.

[Eugene Krabs]

In my personal opinion, I don't think we are in a bear market anymore. But we are not in a bull market either (despite the Dow's 2500 point climb since March). No, the market seems like it's moving sideways to me. Behaving like a "cowardly lion", where it advances, retreats, advances, retreats.

Of course, it still has the potential to go up, and it also has the potential to go down. But that's the point of a cowardly lion market.

Moreover, my trade, which was based on bearish strategies that served me so well back in 2008, is currently under-performing my passive funds! So, if you're a trader, at the very least, I don't think one should trade like a bear anymore.

At least, that's my feeling on the matter. Ultimately, I agree with the late Mr. Bernstein. You can not figure the market out. For those with passive portfolios and eschew trading, good for you and keep on plugging into your set asset allocation.

For traders though, look out for the cowardly lion!