Will the Bear Market Last Until 2014?

Check out this insightful interview dated December 10, 2007 with Russell Napier, author of Anatomy of the Bear: Lessons From Wall Street's Four Great Bottoms. The interview takes several minutes but it is well worth the listen.

Napier studied the four historic market bottoms of the 20th century with major lows created in 1921, 1932, 1949, and 1982. He defines these market bottoms by declines in market valuations. He also comments on the market tops and suggests we reached a market top in 2000 and a new long-term bear could last until 2014. Napier states that there are plenty of great trading opportunities during these long-term bears but they are not “buy and hold” markets. I tend to agree.

Napier’s research is amazing as he read 70,000 Wall Street Journal articles two months prior and two months after each of these bear market bottoms. Based on his research, what sort of headlines should we expect to see before we declare a new market bottom? Napier expects to see plenty of these sort of headlines:

Disgruntlement with the Federal Reserve
Pressure for a new monetary system
Lots of discussion why you should never buy equities
Talk of a possible bond collapse
Dangers of holding your money in a bank
Talk of deflation
Questions about the long-term future of America

In my opinion, we are starting to see some of these headlines but I agree with Napier that we have a ways to go before we hit bottom. If the Fed hadn’t stepped in and bailed out the market over the past 6 months, we might be seeing more of these headlines. In my opinion, the Fed is just prolonging the agony. You may not agree with my opinion. Regardless, Napier’s research is certainly interesting.

How My Investment Strategy Has Changed Over 12 Years

I’ve learned a great deal over the past 12 years of investing. Today I want to share my past investment performance compared to the S&P 500. I also want to share my current investment strategy.

1996-1998
I held a basket of random mutual funds and followed a “buy and hold” strategy. I experienced 3 straight years of underperformance.

1999-2001
I decided to jump on the bandwagon and I chased investment performance. The “dot com” stocks were taking off and I didn’t want to miss out. Unfortunately, my timing was terrible as the “dot com” bubble popped in 2000. As we entered a recession, I wisely sold my “dot com” stocks mid 2001 and cut my losses. During this time, I experienced another 3 straight years of underperformance.

2002-2006
I needed a new approach to investing. As I sold my “dot com” stocks, I made a conscious decision to partially abandon the “buy and hold” strategy.

My new approach was two-fold:
Buy and Hold: Approximately 40% of my portfolio still comprised of a “buy and hold” strategy. I decided to purchase mutual funds with managers who had long tenures and proven track records. I decided to put my money behind Bill Nygren OAKLX and Bill Miller LMVTX. I also invested in OAKEX for international exposure. Overall, these funds performed well for me but these fund managers eventually lost their golden touch.

Market Timing: The other 60% of my portfolio was designated to time the market. This is a very controversial approach to investing, but if you are nimble, then you can be successful. My market timing approach has developed over time but mostly consists of technical analysis, oversold/undersold market indicators, and taking a contrarian approach to market sentiment (I buy when others sell, I sell when others buy).

I outperformed the market 4 out of 5 years during this period.

2007-Present
My current approach to investing is still two-fold. However, my “buy and hold” strategy now consists of 100% index funds implementing lazy portfolios. I continue to be successful in my market timing strategy as I outperformed the market in 2007 and I’m on pace to outperform the market in 2008. However, unless you have proven success in market timing, I don’t recommend it. A market timing approach is not for everyone. I personally recommend lazy portfolios to my family and friends.

Don’t Chase Investment Performance

As my own investment rule, I don’t chase performance. I learned my lesson in the “dot com” bubble. Frequently, investors jump on the hot investments only to later realize they bought at the top. Commodities are a recent example.

On March 5, 2009 a friend wrote:

“I was thinking that some hedge funds … may start to sell positions that have big gains to offset mortgage-related losses - the big gains coming from commodities. I then read in Barron’s that some did not think this would happen because the commodity trade has been strong, will continue, etc. With the gains that wheat, corn, etc have been making, it seems like a good time for them to exit. And, nothing goes up forever. It seems to me that many commodities are in a short-term bubble and if hedge funds start selling, the drop could be severe, but possibly short.”

I replied:

“I definitely wouldn't short any commodities. I considered (for about 1 minute) buying some commodities since they've been on fire but they seem to be priced too high for me. These sort of "bubbles" seem to last longer than they should, however.”

Over the last couple of days we have seen a sharp fall in commodities. Check out Bespoke’s Commodity Snapshot to see how far commodities have fallen in just a few days. The goal is to buy low and sell high. Don’t be tempted to “follow the herd” and pursue the latest hot investment trends.

Investment Advice in Unstable Markets

The stock market, measured by the S&P 500 is down 12.3% this year and down 17.7% from the all time high set last October. During this time, the stock market has been very turbulent, often up big one day and giving those gains back the next day. So what is an investor to do? A recent letter to Vanguard investors gives 4 tips for remaining calm in turbulent markets

1. Maintain a long-term perspective. I’m mixed on this advice. Yes, I do believe in maintaining a long-term perspective in my retirement accounts. However, I’m also a huge advocate of protecting my capital. In a bear market like we are in, sometimes protecting capital should be priority #1. Do you remember the last bear market of 2000-2003? The S&P 500 gave back nearly 50% from the highs. To quote Warren Buffet. "The first rule is not to lose. The second rule is not to forget the first rule. "
2. Tune out the headlines. Last month I wrote about the dangers of getting your investment advice from CNBC.
3. Be balanced and diversified. I maintain a diversified portfolio with a blend of index funds.
4. Have a plan and stick to it. It’s important to write down your financial goals. If you don’t know your investment goals, how can you possibly make the best investment decisions?

So what are you doing in this turbulent market? Are you sticking with your plan?

Can the Dow Reach 24,000,000 by the Year 2100?

Yesterday I recommended lazy portfolios for long-term investing. To help make my case, I quoted Warren Buffet from his annual letter to Berkshire Hathaway shareholders.

Warren Buffet has many other interesting perspectives in his annual letter to shareholders including the following thought:

“I should mention that people who expect to earn 10% annually from equities during this century – envisioning that 2% of that will come from dividends and 8% from price appreciation – are implicitly forecasting a level of about 24,000,000 on the Dow by 2100. If your adviser talks to you about doubledigit returns from equities, explain this math to him – not that it will faze him. Many helpers are apparently direct descendants of the queen in Alice in Wonderland, who said: “Why, sometimes I’ve believed as many as six impossible things before breakfast.” Beware the glib helper who fills your head with fantasies while he fills his pockets with fees.”
- Warren Buffet

Price appreciation of 8% takes the Dow to about 24,000,000 by the year 2100. For investors who expect price appreciation of 10%, the Dow would reach astronomical levels. So the next time your financial advisor promises future returns of 10% per year, perhaps you should remind him at that pace the Dow would reach 158,437,353 by the year 2100. I don’t know about you, but this doesn’t seem achievable to me.

Use Lazy Portfolios for Long-Term Investing

I’m a fan of using a lazy portfolio strategy for long-term investments. A lazy portfolio consists of diversified, low-cost, no-load index funds or exchange-traded funds. Lazy portfolios implement the buy-and-hold strategy with occasional rebalancing. I finally became a convert after reading the excellent work by Charles Kirk. I recommend all my readers spend quality time reading his blog.

My lazy portfolio currently consists of:
45% Vanguard Total Stock Market Index (VTSMX)
45% Vanguard Total International Stock Market Index (VGTSX)
10% Vanguard Total Bond Market Index (VBMFX)

If you don’t believe me, perhaps you will take advice from Warren Buffet's annual letter to Berkshire Hathaway shareholders.

“Naturally, everyone expects to be above average. And those helpers – bless their hearts – will certainly encourage their clients in this belief. But, as a class, the helper-aided group must be below average. The reason is simple: 1) Investors, overall, will necessarily earn an average return, minus costs they incur; 2) Passive and index investors, through their very inactivity, will earn that average minus costs that are very low; 3) With that group earning average returns, so must the remaining group – the active investors. But this group will incur high transaction, management, and advisory costs. Therefore, the active investors will have their returns diminished by a far greater percentage than will their inactive brethren. That means that the passive group – the “know-nothings” – must win”.
- Warren Buffet

I’m convinced almost every investor should fire their highly commissioned financial advisers and brokers and implement a passive lazy portfolio instead.

Investing in the Stock Market with Leverage

Leverage is an investing technique that allows you to use a small amount of your own money with hopes that your investment will increase in value. When you use leverage to buy stocks, you are borrowing money so you can buy more shares then you normally could have afforded. Using leverage to buy stock is called buying on margin. If the stock price goes up, all is well. However, if the stock price goes down, the stock you bought is used as collateral and you could be forced to sell your shares. This is something known as a margin call.

I invested on margin once and only once. In the middle of the dot com bubble, my investments were flying high and I was feeling confident because I owned stocks like Cisco, EMC, Sun Microsystems, and Oracle. I felt compelled to make the most of the rising stock market and I wanted to own more shares than I could afford. I purchased shares on margin and I was highly leveraged.

On August 31, 1998 the Nasdaq dropped 8.6%. Many market observers were predicting another market crash similar to the crash of October 19, 1987 called “Black Monday” when the Dow lost 22.6% of it’s value. The decline on that August day was a scary moment for me because I received a margin call. If the market didn’t recover quickly, I would be forced to sell my shares for a loss. I recall feeling sick and lonely that day and I prepared myself for the worst. Fortunately for me, the Nasdaq quickly recovered and rose 5% the following day and gained back all its losses over the next five trading days. It was an amazing recovery and I was fortunate. That was the last time I invested in the stock market using leverage.

Tomorrow I will discuss using leverage to buy real estate.

Investment Advice from CNBC

Television is made for entertainment and CNBC feeds off drama. The stock market can experience three straight down days and the news anchors on CNBC are talking about the next great recession. Then three days later when the stock market gains back its losses, those same news anchors are cheering the resilient bull market. This sort of bipolar behavior can lead to very bad financial decisions by an individual investor.

Then there are the CNBC guest experts offering stock picks, investment ideas, market forecasts, and analysis. Don’t believe everything you hear from these experts. For every stock tip you hear on CNBC, I guarantee you can find another expert offering the exact opposite advice.

No doubt, CNBC can be entertaining. Just don’t make your next major financial decision based off what you hear there.

Invest in Index Funds

Why do investors pay active fund managers high fees to manage their investments when more than 75% of all fund managers fail to beat the S&P 500 on an annual basis? Don't let your gains slip away by paying these high fees for underperformance. Invest in index funds instead of mutual funds.

I invest with Vanguard and balance my portfolio among a few index funds including the Vanguard Total Stock Market Index (VTSMX), Vanguard Total International Stock Index (VGTSX), and Vanguard Total Bond Market Index (VBMFX).

It's time to put the odds in your favor. You can create your own diversified investment portfolio with only a few index funds. Start today.