Don't be Caught in a Bear Rally - 3 / 13/ 2009

I won't pontificate today. There are very simple ways to protect yourself from being caught in a classic bear trap or bear market rally. I don't know if this is one, my bet is that it is, but I don't know for certain, and no one else knows for certain either. If you listen to the pundits, the "experts" on the 3 financial channels this morning (CNBC, FOX Business, Bloomberg) its a mixed bag. Interviews of traders on the floor of the NYSE are returning answers like, "It's a bit early to tell." and "I don't know which way we are headed." It really amazes me. And frankly if I hear another softball interview done by any of these channels of Pandit, Dimon, or Lewis I may start a new anti financial media website.

Readers, it's times like these we need an expert. And unfortunately Wall Street has been defining expertise as the people who bring the most fees into the firm. Not to the people who actually have an ability to determine with reasonable accuracy which way the market or a particular issue will move over the next month. I am telling you there are no "experts" left.

So its up to you to make a decision. Are you a technical buyer of stocks or are you a fundamental buyer of stocks? Longer term readers will know that the fundamental and relative value investors are the only players that make money over the long haul. And unless you are earning a 2% carry on funds you manage plus a 20% take on profits generated, you should be doing the same.

Sharp upside moves in the markets or in particular industries that apply to all major players in an industry are almost always examples of short covering. Why would Citi move up on a percentage basis similarly to Wells Fargo this week? Are they similar companies with similar risk profiles right now? Of course not. Why would all construction machinery manufacturers share the same 5 day chart patterns? Has the outlook for new major construction projects world wide improved by 20% in the last 5 days? You know the answer. (It's "No".)

We need to remember that share prices have always and will always be valued based upon the expected quality of their future earnings. And frankly every other metric or ratio or chart analysis model is really a fancy way of justifying current prices paid for a stock that is in speculation mode. Ask yourself as an investor of your own money, After the past year, do you feel comfortable paying a price per share of any company that is equal to the estimated next 15 or 19 years worth of earnings? Because if you buy a share of a company's stock when its price is 19.0x earnings, that is exactly what you have done.

Instead start by asking yourself, do you like a particular industry. Then look at the companies in that industry. Of the 5 or 6 largest ones that have shown profits in the last 3 years, which one is trading at a lower multiple than the others. That's the one you look at, not because it has the greatest price upside potential, but because it is the greatest protector of your principal. And you can not compound your earnings in the stock market unless your protect your principal investment first.

If you think and invest like a speculator. If you believe what the Wall Street "experts" tell you, that you must always be in the market or you will miss the upside then ultimately you will participate in the downside too. Market returns over the last 5 years have been negative folks. How many times in that period have you heard buy, buy, buy from the "experts'? How many times have you heard sell? (hint: market professionals don't want you to sell before they do.)

Here's another suggestion, Turn off the TV. Spend 10 minutes with a reasonable, objective information source, (Yahoo Finance, or the SEC filings site, or with Valueline as examples). Choose an industry you like, review the top few companies in that industry, and invest in the one that appears to be trading at a discount to the group. That's how you protect yourself best from the short term swings in the general markets. Like Bear rallies.

We'll cover more on picking good companies to invest in in future editions.

Build Value Every Day.

Brad van Siclen