Don't Feed the (Perma-) Bears

Take stick. Poke bear. Observe.

Ssssh. In the immortal words of Elmer Fudd, "Be vewwy quiet." We're hunting pewmabeaws.

Oh yes, there's one. You can just spot the glowing, bloodshot eyes, straining from intense efforts to avoid positive economic news. The permabear is just to the left, sort of underneath that big, leaning tower of newspapers from the bank meltdown, below the "Paulson Sucks!" poster. Follow the sound of the jingle as he thumbs through his stack of gold coins, muttering about the death of the dollar.

Be careful, though. The permabear can be warm and welcoming to those who share its opinion, but it can fly into an unthinking rage when surprised by discomforting data. Believe me, you want to keep the permabear content with a steady diet of pessimistic news and opinion.

Smarter than the average bear?
Of course, not all permabears are the same.

Some will bet you their entire precious-metals portfolio that rampant, Nigeria-like inflation is on the way because of Bernanke's policy of "printing money from thin air." Others swear that the economy is in for another deflationary deep dive. You can even find individual permabears who argue for simultaneous inflationary and deflationary futures, something all but impossible.

Don't step into the bear trap
While you should avoid living your life among the permabears, it's healthy and invigorating to forage among them from time to time.

I myself was accused of being a permabear for months, having written article after article about the soon-to-end housing bubble, bad lending, idiotic real estate reporting from the mainstream media, and the likelihood of a big drop in consumer spending if it all came tumbling down.

In direct contrast to the doe-eyed talking heads who looked for sunshine in every retail report, I noted several times that when downmarket mavens like Wal-Mart (NYSE: WMT  ) were doing better than their peers, it was an early sign of stressed consumers trading down. I was short the market ETF the summer before the entire thing went boom.

But I learned some valuable lessons from my time among the species. Being right doesn't always make you money. That market short? The puts expired a couple of weeks before stocks got slaughtered.

And even junky companies in a meltdown industry can become bargains. I was bearish on homebuilders like KB Home (NYSE: KBH  ) and Toll Brothers (NYSE: TOL  ) for far too long. I watched in amazement as new home sales continued to drop off a cliff, yet the stocks of the stronger builders didn't go to zero with them.

In fact, most of the big homebuilders have outperformed the S&P 500 since July 2008, when most of them crashed. Being too down on these pieces of bear bait cost me money.

Embrace the bear, cautiously
All that being said, I don't believe we're on a fast trail out of the bear-riddled woods. In fact, I've said time and time again on our weekly Motley Fool Money podcast that the stock recovery looks dangerous to me, since many companies appear to be priced for revenue and earnings growth that would rival what we saw in the days of the Great Excess 2K. I think that's unlikely.

But I don't think we're headed for financial Armageddon, either -- and that's why I refuse to get stuck in the permabear trap. Instead, I do what most rational investors ought to be doing: I continue to look at individual stocks for individual opportunities.

Sometimes, that means embracing the bear argument. If there are permabears out there that believe there's not enough spare yuppie cash to keep Jamba Juice (Nasdaq: JMBA  ) from drowning in a puddle of disgusting wheat-grass squeezings, I agree.

But if you want to argue that suburban moms' must-have label Coach (NYSE: COH  ) is on the same path, we'll have to agree to disagree. I'm not sure Coach is cheap enough to offer me the kind of margin of safety I prefer in a consumer discretionary stock heading into double-digit unemployment, but I sure wouldn't want to short it at 14 times earnings.

Think small. Look for the worst.
Broadly speaking, the reason the recent rally has looked so impressive is that stocks had fallen so far in front of it. Most companies have bounced from their abysmal lows of early 2009, but not all have come roaring back.

That's because while the entire economy isn't on death watch, there are still industries that are in for a long, cold hibernation. Little Dynamic Materials (Nasdaq: BOOM  ) , for instance, serves the oil and gas industries, providing specialized metals for refineries. But since companies like Valero (NYSE: VLO  ) can't even find buyers for the refineries they've taken offline, there's not much investment going on right now, and the small fries suffer.

But if you choose the right companies in such an environment, the ones that will not only survive but will see big increases on the top and bottom line when we get back to normal, you can do very well. And nothing helps get you a bargain price quite like a widespread bout of permabear-itis.

Foolish final thought
Stocks and the economy are linked, but the relationship isn't always clear. That's why it's important to step out of your permabear costume and think more critically about individual companies.

During bouts of bearishness, some companies are priced so cheap that they are worth more as scrap than the stock commands on the exchange. Other companies are just misunderstood.

Taking each company on an individual basis -- and taking advantage of the occasional sales -- is the key to success. Before buying, you need to model potential values for a variety of financial futures, from bearish to rosy. (Sorry, permabears. Could happen.)

That's exactly the stock-by-stock approach we take at Motley Fool Hidden Gems. Better yet, we've updated the service to include real money and real-time buy alerts. We've even begun to produce a video valuation series where we walk members through those financial scenarios, and Dynamic Materials is the latest company under our lens. A risk-free trial will get you access to all of it. Just click here to get started.

Already subscribe to Hidden Gems? Log in at the top of this page.

Seth Jayson is co-advisor of Motley Fool Hidden Gems. At the time of publication, he had no position in any company mentioned here. Dynamic Materials is a Motley Fool Hidden Gems recommendation. Coach is a Stock Advisor pick. Wal-Mart is an Inside Value choice. The Motley Fool owns shares of Dynamic Materials and has an optimistic disclosure policy.


Read/Post Comments (20) | Recommend This Article (51)

Comments from our Foolish Readers

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 September 15, 2009, at 1:21 PM, davewrink4257 wrote:

    Hey, why all the sarcasim? Bernake says

    the recession if likely over. Unemployment will lag behind..so I guess the recession for those that never felt the recession...is over. aaa. OK! What are the rest of us suppose to do? apply for commodities.and when I say commodities..I mean..like..where are they handing out can goods and apple sauce and corn meal today in the Little Rock area. Seriously, I recently went to the arkansas work force....now in their 3rd new building...5 times as large as the previous two..and there are cars circling around like it is the Sonic Drive in in a small town on a Saturday night..except there is no one..giving away cherry limes and tater tots. There are 300 people...mostly African American women and White Construction workers and a few others..wondering...when they can go back to get their 4 minute interview for their possible puny unemployment check...but...as the TV news on Fox says..the Recession is likely over.

  • Report this Comment On September 15, 2009, at 1:25 PM, TMFBent wrote:

    employment is allways a lagging recession indicator, alas.

  • Report this Comment On September 15, 2009, at 2:37 PM, ST0CKTRADER wrote:

    i would disagree on jamba juice they are on the verge or another 52 week high, they've just started offering food items to help lure in the lunch crowd, plus there is lots of insider buying right now, and in comparison to its peers jmba is vastly undervalued.

  • Report this Comment On September 15, 2009, at 3:28 PM, clanza875 wrote:

    I also disagree on Jamba Juice. The new CEO is doing a great job with the turnaround plan. Never count out the yuppie cash either.

  • Report this Comment On September 15, 2009, at 6:55 PM, Ruhaan wrote:

    ok something to agree or disagree on wgat.ob. Many may not have even heard of it but it spots a mkt cap of 450MM on sales of 3MM..

    Wish I could sell it short on caps..

  • Report this Comment On September 15, 2009, at 11:51 PM, automaticaev wrote:

    everyone needs to buy muscets made of solid silver that shoot gold bullion.

  • Report this Comment On September 16, 2009, at 12:15 AM, automaticaev wrote:

    and dont forget to install a lvl 4 bioshelter under your basement.

  • Report this Comment On September 16, 2009, at 12:18 AM, topsecret09 wrote:

    Take stick. Poke bear. Observe. LOL !!!!

  • Report this Comment On September 16, 2009, at 3:53 AM, saunafool wrote:

    "Seriously, I recently went to the arkansas work force....now in their 3rd new building...5 times as large as the previous two..and there are cars circling around like it is the Sonic Drive in in a small town on a Saturday night..except there is no one..giving away cherry limes and tater tots."

    Now, that is some funny writin' there.

  • Report this Comment On September 16, 2009, at 6:56 AM, Ibeatmykids wrote:

    I can't wait until everyone gets there jobs back. You know who I am talking about. All of you people who waste the companies money doing nothing anyway. If you ask me, American's claim to work more hours and get paid less. I am willing to bet that since the invention of youtube that productivity has plummeted. Youtube is probably the whole reason for this recession.

    I got a little off topic but the point is that America is full of whiny lazy obese slobs now. The economy won't ever be quite the same. And now that I will soon have to pay for your triple bi-pass as I live a healthy lifestyle is like rubbing salt in the wound.

    America is going down the tubes and as long as the dollar goes with it I will keep my investments and cash in when the DOW hits 50,000.

  • Report this Comment On September 16, 2009, at 7:52 AM, TMFBent wrote:

    What you see on the street right now isn't always indicative of overall economic reality. Our office is located in a busted boom area, and 3 blocks from here, there are empty commercial properties up the wazoo. A (bruggers?) bagel place opened up and closed within a year or so. The premier corner location on the big new building is now trying to get a special use permit so that it can let a 7-11 in. (Yeah, they are still trying to market the lofts above as chic and worth 100s of $K, but they're shoving a lousy 7-11 into the bottom of the building.)

    Across the street from that one, there's a nearly identical one that was just completed and is completely empty.

    Yet, 3 blocks away, the first buildings in the development aren't nearly so bad off.

    So where's the reality? If you put blinders on and look at the empty excess, you'll think there's no hope. Look only at the full properties, and you'll be a Pollyanna.

    As with most things, the truth isn't so simple. There are plenty of companies yet to disappear, and many more that will thrive and produce amazing returns. You miss the chance to discern which is which when you glaze over, no matter which side you pick.

  • Report this Comment On September 16, 2009, at 10:20 AM, bigpeach wrote:

    Seth,

    Perfect! Unfortunately, with the permabears, it seems to be more than just being blind to good news. Certainly that is a large part of it, but many also seem to have become emotionally invested in their dire predictions. There is an air of needing to be right, so as not to look foolish, and (dare I say it) to be able to say "I told you so."

  • Report this Comment On September 16, 2009, at 10:49 AM, bigcat1969 wrote:

    Optimism all you need is optimism. And the 12 trillion dollars spent by governments worldwide.

    Optimism all you need is optimism. And 9 out of 10 new mortgages backed by the government.

    Optimism all you need is optimism. And a couple banks shut down every Friday.

    Optimism all you need is optimism. And a return to systemic risk and CDS underwritten by anyone with a pen and a sucker.

    Optimism all you need is optimism. And we will send those evil bears back into hibernation like they were for the last decade when the US stock market had the best ten year run in history!

    The zero man typeth.

  • Report this Comment On September 16, 2009, at 12:40 PM, TMFBent wrote:

    "but many also seem to have become emotionally invested in their dire predictions. There is an air of needing to be right, so as not to look foolish, and (dare I say it) to be able to say "I told you so.""

    Yup. Personally, I'd rather make some money than cleave to some outlook because I've gotten my ego or personality wrapped up in it. There's a lot of demagoguery on the internets (no surprise there) but some of the most amazing you see right here in CAPS blogs. A while back, the permabears came out clawing in full force on my blog because I simply asked the question: what will they do if the world doesn't come to an end?

    Amazingly, many then presumed to accuse me of always having a sunny outlook on stocks, the economy, etc. They had done no homework at all to see that this was untrue. Instead, they were clininging to their conclusions without any data to support them. If the average permabear conducts his 'research" into economic trends with the same rigor and thoughtfulness, I'd say he'll soon be considered an excellent contrary indicator.

  • Report this Comment On September 16, 2009, at 3:02 PM, nycpro21 wrote:

    Motley Fools behind the curve on BOOM!

    How can Motley Fools say that BOOM is in bear mode????? On the same day AP reported:

    BOULDER, Colo. (AP) -- Clad metal plates maker Dynamic Materials Corp. said Friday its explosive metalworking business received two related orders with a combined value of $14.8 million.

    ...

    The company's CEO Yvon Cariou said this is one of the largest cumulative orders in Dynamic Materials' history.

    What gives, Motley Fools? Also, I posted this earlier today and never saw it listed. I'm trying 2nd time today.

  • Report this Comment On September 16, 2009, at 4:16 PM, TMFBent wrote:

    "Motley Fools behind the curve on BOOM!

    How can Motley Fools say that BOOM is in bear mode????? On the same day AP reported..."

    Hardly. The order is nice, but the reality is that revenues are depressed and will remain so for some time.

    But we've not been behind the curve at all on BOOM. We bought shares at $8 and change on March 31...

    Sj

  • Report this Comment On September 17, 2009, at 11:53 AM, nycdrew wrote:

    hey Seth,

    stock is up 20% today in your face, nice call genius... plenty of yuppy cash, and yuppy kids cash you douche

  • Report this Comment On September 17, 2009, at 1:44 PM, MKArch wrote:

    Excellent article Seth. I'm a bit of an optimist and took it on the chin when the economy collapsed last fall. I can attest to the fact that you were part of what I considered at the time the permabear club. I found it annoying to have to constantly read permabear articles rejoicing in the crash they predicted was coming and not so secretly hoping for more to teach some lessons.

    While I understand corrections are a necessary evil to undue excesses that build up I always believed that the severity of the economic and market collapse was due to panic more than working off excesses. I quietly took my lumps used the sell off to reposition my portfolio into the best opportunities that I thought the market was offering and wait for everyone to calm down and realize the world actually wasn't coming to an end and this whole thing was an over reaction.

    It's nice and refreshing to see someone who I thought at the time was rejoicing maybe just a bit at being right about the world coming to an end now ready to admit that it probably isn't the end of the world. The crash probably offered up some good lessons to eternal optimist and permabears if you have an open mind.

    Mike

  • Report this Comment On September 18, 2009, at 1:05 PM, 2humble2fool wrote:

    Seth,

    Whether you are right, wrong or somewhere in between it is refreshing to read that someone who was spot-on on the crash didn't profit because of the timing. Personally, I think that both the Bulls and the Bears are half wrong. We probably aren't going to zoom to new heights any time soon, but it isn't the end of the world as we know it either. For me who is about ten years from needing to take dollars out of my portfolio, I'm going with the idea that things will be straightened out and the market will have resumed its long-term upward trend by then. Thus, I'm watching what's going on, but I'm not changing my investment strategy because of it. Thanks for a great article.

  • Report this Comment On September 22, 2009, at 12:14 PM, deadlysaber wrote:

    By using options with a small percentage of your overall portfolio, you can construct bear put spread positions that profit from weaknesses in stocks. This allows you to enhance your over-all return, while smoothing out your portfolio's equity swings.

    Before we discuss the details, this caveat bears repeating: no matter how lucrative options appear, remember that they are a "swinging for the fences" type of play. You have to be right on both market direction and timing, so there is a very likely chance that you will "strike out" and lose your investment. But, when you are successful, you can make large percentage returns. You should limit options activity to 10% or less of your portfolio.

    A bear put spread is an options position that is created by buying a put option on a stock that you think will decline, and then simultaneously selling short another put option on the same stock that has the same expiration, but a lower strike price.

    The bear put spread has a higher chance of success than just buying a put option, because it reduces your purchase price. The trade-off is that if the stock really tanks before the options expire, and drops below the strike price of the short option, you will not make as much money as a simple long put position. In fact, the maximum profit on a bear put spread is equal to the difference in strikes. This maximum profit occurs when the stock price drops to the strike part of the short put.

    ----------------------

    Money without intelligence is like a car without a road.

    http://www.intelligentinvestingtips.com

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