For campers and hikers in most areas of the U.S., a basic knowledge of bears is essential. Granted, it's unlikely that you'll ever run across one in the wild, but if you do, it could be a life-threatening experience. I figure it's worth the small time investment to learn how to react to a bear encounter.
Similarly, stock market bears can be severely hazardous to your financial health, and if you plan to navigate the backwoods of the stock market, it helps to understand them. Not all bears -- stock market or otherwise -- are alike, and it's important to know the best response for each species.
The black bear
Black bears are the scavengers of the bear family, and the most skittish as well. They are typically the smallest variety of bear and the least dangerous by far, since their first reaction is always to hide. When confronted by a black bear, running is the worst thing to do -- it will encourage the bear and cause it to give chase. The best thing to do is to make yourself look as large as possible, and fight back if the bear does approach.
The market equivalent of the black bear shares a lot of the same traits. These traders are generally looking for weak, easy marks in which they think they can make a quick profit. They tend to be fairly skittish, though, and will retreat quickly if the stock starts to move against them. Doing your research and being confident in your analysis is the best way to defend yourself from this kind of bear. When you know that your stock is backed by a strong company that's performing well, it's easier to step in and take advantage of any short-term weaknesses these bears create. As with the real-life black bears, retreating out of the stock will only encourage them, and you'll also likely end up missing out on the recovery when the bears are finally chased away.
At the beginning of the summer, Akamai Technologies (NASDAQ:AKAM) endured a pair of bear attacks that clawed 25% and 20%, respectively, from its share price. Despite this, Akamai continued to perform as a company, beating both Q2 and Q3 analyst estimates by $0.02. Needless to say, the bears were easily scared off, and investors enjoyed a ride from $29.50 at the bottom of the second scare to just more than $52 at the beginning of October.
The market as a whole sees similar types of bear strikes. Over the same time period as the Akamai episode, the S&P sold off around 8%, as worries over the economy, the housing market, and interest rates encouraged some hungry bears. But on the back of strong fundamentals, the market quickly rallied back from that. Today, we're around 4% above where we were before the summer dip.
The grizzly bear
Also known as the brown bear, the grizzly is a much larger and far more dangerous relative of the black bear. Grizzlies are not scavengers, like black bears, and usually have a good reason for attacking when they do get aggressive. Though they are harder to scare off than black bears, and fighting back would prove fairly useless, playing dead has been found to be a pretty good defense in an encounter with a grizzly.
Recently, the stocks of Dell (NASDAQ:DELL) and Intel (NASDAQ:INTC) have tasted the pain of a grizzly bear attack. Dell was whacked down more than 50% from July of 2005 to July of this year, and Intel has been gutted nearly as much since touching $34 in early 2004. These haircuts haven't been without reason; in the PC market, longtime sleeper Hewlett-Packard (NYSE:HPQ) has awakened under the leadership of new CEO Mark Hurd, and it's begun giving the dudes at Dell a run for their money. And in Intel's world, former also-ran Advanced Micro Devices (NYSE:AMD) has been causing quite a stir as well.
Grizzly attacks in the stock market frequently befall stocks that have solid companies and strong fundamentals behind them. The stock's price may be too high, or a readjustment may be in line because of new developments, but in most cases, we're not talking about a company that's going to disappear. The best strategy with these situations is to lay low for a while and wait for the dust to settle. When everyone has written off the stock, there's a pretty good chance that it's reached the point of being undervalued. During the bubble in 2000, Cisco (NASDAQ:CSCO) got overvalued along with a host of other tech companies; but unlike the Webvans of the time, Cisco was putting cash in the bank. From peak to trough, Cisco plunged from nearly $80 to just less than $10. In the year after it bottomed, though, patient investors saw its stock more than triple.
Episodes like the crash of 2000 or the crash of 1929 are grizzly type assaults on the entire market. These were times when investors got ahead of themselves and speculation ran the market up to precarious levels. While the ensuing corrections were painful, patient investors who stayed the course were able to profit from these huge price drops.
The polar bear
The last type of bear is the polar bear, a massive predator that has been seen to grow as large as twelve feet long and weigh 2,200 pounds. These killing machines can easily outrun a human, and they swim like champs. Unfortunately, there is really very little you can do when a polar bear comes to visit -- unless you happen to have a few hand grenades. Luckily, polar bears live in areas like Alaska, Siberia, and Greenland, away from areas heavily populated by humans
A polar bear encounter in the stock market is likewise extremely dangerous. Most of these attacks are on stocks like Webvan, Pets.com, or MiniScribe that are never heard from again. The stocks that get hit like this are backed up by companies that could never find a way to produce shareholder value, which allows the bears to have the final say. While it's tough to say for sure what stocks are following the dodo into extinction, some stocks out there, such as Pegasus Wireless and Credence Systems (NASDAQ:CMOS), are likely well on their way. Of course, larger issues aren't all safe, and well-known companies like XM Satellite Radio (NASDAQ:XMSR) and Blockbuster (NYSE:BBI) could likewise get dragged down by the big white bear if they can't find a way to stem the cash burn.
Foolish bears of every kind:
Dell and Intel are Motley Fool Inside Value selections. Akamai and XM Satellite Radio are Rule Breakers recommendations.
Fool contributor Matt Koppenheffer does not consider himself a bear of any color. He knows that the Fool's disclosure policy has teeth, though.
