Tuesday, February 12, 2008

Bear Markets

For my first Blog post, I have to respond to the comments that the stock markets are entering "Bear Territory". I was watching CNN the other day and they were talking about the Dow Jones and the Nasdaq entering bear territory, and I couldn't help but cringe. There should be no such thing as a bear market at this point. We understand the mechanics of the stock market, and have had many years to figure things out.

First of all, people associate bear markets with recession. Recession is caused by lower national spending. Lower spending is associated with higher saving. So, if we are saving this money, where is it going? Certainly not into...say...the stock market? Even if individuals stop investing in the stock market, the big players (banks, trusts, etc.) are certainly investing their money in the markets. So to say that a recession and a bear market go together is incorrect. If anything, a recession should trigger a bull market, as people invest (or save) their money instead of spending it.

Next I would like to talk about what a bear market entails. Lower stock prices (particularly the index funds) lead people to think that the bear is in the house. The way I see it, lower stock prices mean that it is time to invest! This is when the stocks are on sale, to take a term from retail. If you had a choice of buying a thousand shares of a solid company (think blue-chip) at $100 a share or at $85 a share, what would you pick? As an investor, one should look at the bear market as an opportunity. Stocks almost always recover (barring bad management), so why not throw some more money into the pot when the stocks are cheap? If I go to buy a car, I look at a number of factors - price, functionality, features, safetey, etc. Why not apply the same formula to the stock market? Price should not be the main concern - the management and potential of the company should dictate one's investments. If a company has a solid product line and excellent management, they will be able to weather almost anything that comes along. Even a recession.

Thirdly, I would like to talk about stock market returns. One can not look at the stock market as a way to make a quick buck. I remember back when I was in high school all the talk was about Bre-X. Everywhere I turned, people were talking about this hot stock. Well, I warned them. I said don't invest in companies that have high market valuations. Well, look what happened. A lot of people lost their shirts in the Bre-X scandal. They bought when the stock was very high (one of my friends purchased shares when they were over $200/share), and a lot of people lost everything. The smart thing to do would have been to invest in a company that had an under-market valuation. At approximately the same time I started following the shares of Corel Corp. They were hovering around $2-3/share. At the time of writing, they are at $8.77/share. This is significant return (300% in 10 years). They peaked in 1999 around $60/share. So, who is the smart investor there? Look at a company's history, their potential, and their products to make a decision - not CNN's news feed. I believe it was my father who told me "If a company is in the news, it's too late to invest". What a great rule of thumb. Do your research and you will do well. Invest based on news stories and you will always be behind those who do their research.

Finally, and back to the point of bear markets, one has to look at the performance of their own portfolio. If your portfolio is being outperformed by the index funds, you may want to diversify. If you invest heavily in one or two sectors, you leave yourself open to failure. If you diversify your portfolio, you will be able to have gains and losses that yield you a net gain across the board, even if one or two sectors start to fall. A good example of this is the tech sector. Does anyone else remember the tech bubble? Does anyone remember when it burst? I do. A lot of people lost a lot of money because they were invested heavily in tech stocks. Everyone was talking about when the bubble would burst, but nobody wanted to get out. Everyone was buying, and when we finally realised as a society that these companies were not producing any revenue, everyone sold at the same time - the bubble burst. The smart thing to do would be to invest elsewhere - resources, for example, and when the bubble did burst, be there to happily pick up the stocks of the companies that were actually solid investments from the start - at bargain basement prices.

So, in conclusion, a bear market is really just a clearance sale for stocks. It's a time to invest, not a time to sell. It may be a time to shift your investments around to create a well-balanced portfolio. The real key though is not to sell when the markets are down. If you can't afford to invest more, keep what you've got. Over any given 30 year period, the stock market has ALWAYS outperformed any other investment vehicle, including real estate, treasury bills, GICs, and bonds. People who look at stocks as a get-rich-quick scheme are missing the point. The stock market is an investment. So invest. Don't try to get rich off of one big hit, plan for the long term and buy stocks that have low market valuation and high potential.