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Will The Bears Eat Us Alive?

May 21, 2010 by   Filed under Editorials

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I sent a note to our Stanford Wealth managed clients yesterday about the plunging market. As regular SA readers know, I became wary of this increasingly thin and reedy market in my first 2010 SA article, Do Bears (or Bear Markets) Still Hibernate in Winter?

I was early in my suggestion that you review VXX, TBT and TMV at the end of that article (and I was too early in buying them, as I note in the letter to our clients below.) But I re-stated my concerns and re-doubled my efforts in March and April, as evidenced by the mid-March article, Strategy for the Current Market? Time to Cut Back the Limbs and Feed the Roots .

VXX was 24 then and I began averaging down over the next two weeks as it slid, at one point, all the way to 18 and a fraction. From then, as the market began to roll over, slowly at first ” as you can see in the chart below, click to enlarge, – then, as is typical of sideways bear markets, with increasing velocity, VXX was off to the races.

I say this not to crow ” our profits in VXX have been completely offset by our losses in TBT and TMV, also discussed in my note below, leaving us no better off than if we had simply gone to 100% cash and avoided all the drama ” but to illuminate. What 80% of the crowd believes at 100% intensity will simply never happen. There are too many people wearing blinders and investing with hope and change rather than common sense and a dollop of caution.

But the same will always be true on the downside, as well. May 20th was an ugly day for investors. But it was just that ” one day. One day, one week, one month, are swallowed up in the grand scheme of an investing lifetime. And it is what we do now that we are tested that will determine the kind of investor we are. As Ralph Waldo Emerson said long ago, “This time, like all times, is a very good one if we but know what to do with it.” What follows are our initial thoughts on what to do with it:

Dear Stanford Wealth Management client,

Markets fluctuate. And markets that get ahead of themselves correct.

Clients with us through many market cycles are accustomed to seeing these cycles and accustomed to seeing that we do our best to mitigate the shock of the volatility that always accompanies pullbacks. Markets decline faster and more violently than they rise. Always have, always will. Many newer clients have called in recent weeks to inquire why we held such a high cash cushion. This typically volatile pullback should answer that question. There’s a time to be fully invested and a time to hold some cash in reserve.

It was logical for the market to rise off its 2008 lows in 2009. But we became increasingly concerned as it sliced through 10,000, then shot well above 11,000. That’s when we began (1) raising cash, (2) buying bond funds and other high-income-producing securities, and (3) buying gold and silver producers. As happens in every pullback, only (1) cash gives complete protection. When people panic, they sell solid income producers yielding 9% until they decline to a point where they might yield 11%, 12% or more. It’s dumb, but they read the scare headlines and sell at any price. That is the time to be buying such securities, not selling them. The ones already in your accounts are down, typically 5-10%. So we may average down our cost basis.

Also, this pullback is yet another example that gold does *not* travel opposite the market. Your precious metal investments *may* move independently of the equities markets ( as may bonds) but in a panic, most people sell everything and anything at the worst time, then wait to buy until they’ve heard months of good news. Your gold and silver investments are down as well (although many of you own them at such a low price that they are still profitable.)

What do I wish I hadn’t bought that is down as bad or worse than the market itself? Our short US Treasury ETFs. No matter how profligate our government is, no matter how sure I am that running the printing presses 24/7 will result in high inflation and rising rates ” that’s been delayed by the current crisis. And in crisis, people, institutions and governments panic to “safety.” So Treasury bonds that I am convinced will decline long-term are skyrocketing short term. It hurts, but now is not the time to sell them. If anything, as the euro crisis either subsides or dissolves, it would be the time to buy.

What am I glad we bought as “extra” insurance? For some, the short ETFs on emerging markets and US small caps, both typically more volatile than the Dow or the S&P 500. And of course the VIX ETF (VXX.) We bought it too early but then averaged down to where all positions are profitable. It has been an antidote to the short Treasury ETFs. Expecting a bounce either at option expiration tomorrow or next Monday, even if short-lived, we are now selling some part of your VXX to nail down a tidy profit.

Please keep and refer to the April Investor’s Edge for a “Big Picture” perspective on sideways bear markets. The excellent chart on page 2, compiled by my competitor and friend Sy Harding [Note to SA readers: I published this chart on SA here.] will help you remember: Markets fluctuate. The time to begin buying again is when everyone else is panicking. This, too, shall pass.

Don’t be surprised if I sell at least some of our bond funds that are down only 10% to buy some quality companies that are now down 30%-40%.

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