Welcoming the Bear Market: What to Do Now

As Mr. Market's mood has increasingly soured, we've slipped, slid, and otherwise lurched closer and closer to, and now finally hit, what the TV folks call an "official" bear market -- that is, a 20% drop from the previous high.

Back on April 29, the S&P 500 closed out at 1,363.61, which means that the action this morning -- which dragged the S&P as low as 1,074.77 -- leaves us with a decline that's a bit more than 21%. Clearly it's time to panic, right?

Some perspective can often help in these situations. The last time we were talking about a bear market was just last summer. We didn't hit the "official" level, but between April and July the S&P shed 16%. The rally that followed added 34% back to the S&P index. Even at today's intraday low, the index is still 5% above the summer of 2010 low.

But perhaps that's cold comfort for investors who are watching their portfolio values fall day after day and listening to dire prognostications about the demise of Greece and the entire eurozone. Investors fear the U.S. will be choked by high unemployment and the big banks will reveal themselves to be zombies and eat our brains.

Should any sober investor really stick around through this gruesomeness?

Bring out your chimps!
Most of today's macroeconomic forecasts sound positively frightful. And there are a lot of supposedly smart people who are behind these forecasts. But I check myself from putting too much weight in these forecasts.

As my fellow Fool Morgan Housel pointed out last year (when people were talking bear market), investors need to be careful when it comes to expert forecasts. Citing U.C. Berkeley professor Philip Tetlock, Morgan noted:

  • As a group, expert forecasters are not very good at all at what they do and typically would lose out to a "dart-throwing chimp."
  • Experience doesn't seem to help since there's little correlation between experience and accuracy.
  • The folks that you see most often on TV are the worst ones of all to listen to. Tetlock actually found a negative correlation between an expert's popularity and accuracy.

I'm not suggesting you put your head in the sand and completely ignore the macroeconomic risks, but, despite what the title "expert" might imply, a consensus by the experts that dire times are ahead does not mean the outcome is written in stone. In a more recent article, Morgan highlighted that some of the big, world-changing outcomes that experts seemed to think were inevitable never ended up happening.

Learning to love the bomb
One of the strange quirks that the average Joe has is that he's jubilant when a big electronics retailer puts flat-screen TVs on sale and will rush out to buy one. But when stock prices fall, he gets depressed and can think about nothing but selling.

As a result, when the market goes into sell mode, investors often pay increasingly little attention to what the businesses that they're selling are actually worth. That means market declines are a great time for investors with their heads on straight to pick up stocks at great prices.

My fellow Fool Chuck Saletta recently put it very simply: "When you buy stocks, you trade your cash for a chunk of a business. The lower the price of the shares you're buying, the more of them you can pick up for your money."

Since this "bear market decline" started in late April, the overall market drop has brought down both the price and valuation of many great companies.

Company

Stock Change April 29, 2011, to Oct. 3, 2011

Forward Price-to-Earnings Ratio April 29, 2011

Current Forward Price-to-Earnings Ratio

Corning (NYSE: GLW  ) (43%) 10.1 6.7
Ford (NYSE: F  ) (39%) 8.1 5.3
Freeport-McMoRan (NYSE: FCX  ) (46%) 8.5 4.8
EMC (NYSE: EMC  ) (28%) 18.4 13.0
General Electric (NYSE: GE  ) (28%) 14.5 10.1

 Source: Capital IQ, a division of Standard & Poor's.

Is now the best time to buy stocks? I really don't know. The market can be moved just as easily by hard-to-predict psychology as it can by real fundamentals, and if it does continue to go lower, investors may be able to buy for a better price.

What I can say though is that today is a much better time to buy than five months ago when prices were 20% higher (or more!). With that in mind, is this the right time to be a seller? You tell me.

In the meantime, even if you're not quite ready to jump in and buy, you can add any of the stocks above to your watchlist by clicking the "+" next to the ticker. And if you don't have a watchlist yet? That's no problemo! Just click here to get one started for free.

The Motley Fool owns shares of Ford Motor and EMC. Motley Fool newsletter services have recommended buying shares of Ford Motor and Corning. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer does not have a financial interest in any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.

 


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 04, 2011, at 6:35 PM, pryan37bb wrote:

    I would definitely be buying into this weakness. Two of my core holdings, Ford and GE, which you mentioned in your article, are trading at such deep discounts I thought I'd never see, and I added to my Ford position a few days ago. Its median target is like $18, and it's got more than $5 cash per share on its balance sheet, according to Yahoo Finance. Mulally is cleaning up the balance sheet, and investment-grade debt and dividend reinstatement is right around the corner.

    For people who want to invest but worry about further declines, I would suggest a married put, which is basically buying enough puts to fully protect your holdings. That way, you can clearly define your maximum downside, and if the stock slides but you still want to hold your shares, you can sell the put for a nice profit and effectively reduce your cost basis in that stock.

    FTR yielding more than 13%? Pinch me, I must be dreaming.

  • Report this Comment On October 04, 2011, at 10:35 PM, jimmy4040 wrote:

    Not FCX, unless you plan to hold for quite a while. Copper prices are near collapse unless a europe solution is found.

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