I figured that if even half made it to adulthood, this fall I would have an abundant source of free-range chicken eggs. In the past with just three or four chickens it seemed like there were always more eggs than we could use.

I never counted on the fox. I live in an urban area where foxes are relatively uncommon. But it only takes one and this one has killed as many as five chickens in a single night. I am now down to two hens and one rooster. I’ll be lucky to have enough eggs to make pancakes for breakfast, let alone enough for scrambled eggs.

So far my efforts to hasten the fox’s entrance into the afterlife have been unsuccessful. But I am holding out hope that the remaining three chickens will survive because they have learned to fly into the barn rafters when the fox makes an appearance.

At some point I realized this experience has many parallels with what investors experience during bear markets.

When investors first put money into the markets, it is only natural that they start anticipating the gains they will make in the near future. If they happen to invest at the right time in a bull market, the money seems to grow quickly. But if their investment is followed by a bear market, they money they invest immediately starts to diminish.

As the account value declines, the reaction from investors is to assume that there is a serious problem. After all, the whole point of investing is to see one’s money grow. Unfortunately, bear markets are as much a part of the economic cycle as bull markets.

Like the fox that is killing my chickens, bear markets give their victims a sense of helplessness. There simply is no way to quickly and easily resolve the problem. Although there are several actions one can take, there is no assurance that any of them will work.

I started by trying to make sure my chickens were safe in their coop at night. But one night the fox figured out a way into the coop. Trapped inside with the fox, the chickens were easy pickings.

I have set traps for the fox, but so far he has not been cooperative about entering.

I have a shotgun by the back door, but the one time I saw him carrying off a chicken he was out of range.

I am now resigned to the fact that survival of the last three chickens is pretty much up to them and out of my control.

An investor trapped in a bear market can try to find an investment that is inversely correlated. During the 2000-2002 bear market many investors moved assets out of the financial markets and into real estate. While a few got lucky, it hasn’t worked out very well for many others. Right now it is very difficult to find any sector of the economy that is advancing. Chasing short-term moves in an attempt to make money often results in investors being caught in moves Wall Street calls “bear traps.”

Those who espouse a buy-and-hold approach would have investors stay in the market and ride out the downturn. There argument is that things will eventually improve and the market will bounce back. Unfortunately that is not a realistic option for investors who are retired or who are near retirement.

Some try to make money in a down market by shorting. In other words, they make a bet that the downturn will continue. But it is a risky gamble and really only suitable for very aggressive investors who can withstand significant losses if the market turns up quickly.

Although it is difficult to accept, during a bear market investors need to stop thinking “how can I make money?” and start thinking “how can I avoid losing money?”

During most bear markets the very best course of action is to move to the sidelines and wait for a new upward trend. By their nature, financial markets are cyclical and bear markets will always be followed by bull markets. That raises the obvious question: When can I get more chickens?

Unless the fox ends up in a trap or within range of the shotgun, buying more chickens right now would seem to be less than prudent.

Perhaps you were thinking of the other question: How does one know when it is safe to move back into the market?

That is when it helps to have a thorough understanding of fundamental and technical analysis. Or if you use the services of a professional money manager, that is why it might be worth paying a management fee even when your account is just sitting in a money market fund.
F.S.

Of 806 funds tracked by Yahoo!, 148 have positive returns for the year so far. That means 82% of all ETFs are negative.

Breaking down that 148, 52 are energy or natural resource funds. Returns from that group range from less than 1% to 73.7%. The highest return was posted by United States Natural Gas Fund (UNG). Another 35 are bear market or short funds. In that group returns ranged from 3% up to 57%.

Unfortunately, gains are only half the story. Most investors have not participated in these profits because these funds are generally much too volatile. For example, although UNG is showing a nice gain for the year, it has fallen 42% in the past six weeks. Based on trading volume, many investors bought in near the price peak and have lost significant money since then.

Below is a list of the remaining 60 ETFs and their year-to-date gains. You’ll see that it is quite a diversified list including precious metals funds, currency funds, and even municipal bond funds. Most of these funds carry high risk. So while it is easy to look at the gains and wish we had those in our accounts, just keep in mind that for every two of these funds that show a profit, there are eight others that have suffered losses in 2008.

So what does all this mean? Not much, other than what we already know: so far it has been very difficult to make money in the markets in 2008. Perhaps more important, so far it has been very easy too lose money–in some cases a lot of money–in 2008. So if you are looking at your statements and seeing single-digit losses for the year, you can take heart in knowing that you are probably better off than the majority of investors.

Summer is quickly coming to an end. My wife is a school teacher and she has been working for two weeks already in preparation for the school year. Children in her district will be in class on Monday.

The good news is that the end of summer often is good for the markets. People come back from vacation, Congress goes back into session, and Americans resume a more normal pattern of living and spending. Enjoy the last of your summer and hope for better investment conditions in the coming weeks.

F.S.

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While the picture remains gloomy for now, there are a number of reasons that investors should start preparing for the end of this downturn. For example, the U.S. Department of Labor reported that unemployment jumped 0.5% in May 2008. In the past 50 years, this is only the 12th time that the jobless rate has jumped that much in a single month. The previous 11 times, in the 12 months following the S&P 500 has risen by at least 17.6% and the average gain was 26.8%.

The Wall Street Journal reported that earnings per share of the S&P 500 companies in the second quarter of 2008 are expected to be 18% below the same quarter in 2007. It will mark the fourth consecutive quarter of smaller profits. The all-time record for declining earnings is five straight quarters.

The current bear market is the 14th to occur since 1950. The average duration of the previous 13 bear markets is about 15 months. The current bear market began in October 2007. It will reach that 15-month mark about the end of the year.

One can argue that the circumstances surrounding this bear market are very serious and could prolong its impact. But the truth is that the situations that create any bear market are grave and unusual. The bear market that began in 2000 was already a year old when terrorists brought down the World Trade Center. That event deepened and extended the bear market to one of the worst in the history of the financial markets. The current situation is not nearly as dire.

Below is a chart of the S&P 500 over the past decade. One can easily see the severity of the 2000-2002 bear market. But you can also see the bear market we are now enduring is no slouch. The bottom portion of the chart is a moving average convergence divergence and it shows that we have not seen this kind of volatility for more than five years. 

Of course just because we think the end of this bear is in sight does not mean anyone can pinpoint the exact bottom. As an investor I’d be a little cautious about jumping back into the market at this point. On the other hand, now is undoubtedly a better time than last October!

I can’t tell you what the catalyst will be that will start the next bull market. It could happen when the price of oil drops below $100 a barrel. It could be the presidential election. So while it is easy to be discouraged right now and to start to believe that this will never end, take heart. That usually means the bottom is right around the corner.
F.S.

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I think I can shed some light on the situation with a chart. Below you can see the how the three major indices have performed this year. While these indices have a high level of correlation, there is normally still some separation in their performances and the chart shows that normal distance among the three in the early part of 2008. As the chart clearly shows, however, since the beginning of June, the Nasdaq, Dow and S&P 500 have moved in a virtual lock step.

Another thing the chart clearly shows is that each of these indexes has given up a significant amount so far this year. Since peaking in October 2007, major indices are off more than 20%. If the chart went back far enough, you could see that the pattern since October bears a strong resemblance to 2002.

I wish I could provide some encouraging reasons to show that we are near the end of the current bear cycle. Unfortunately, economic fundamentals appear to be losing ground instead of improving. Staying on the sidelines in cash remains the wisest course of action for most investors.
F.S.

Currently we have analysts and economists arguing about whether the economy is in recession or not. We worry about the cost of oil and wonder if we will have to go from four cars to three. As a nation we have become so wealthy that it is all a bit surreal. Is it any wonder that the rest of the world looks at our lifestyle and either hates us for it, or covets it, or both?

Below is a chart showing the price movement of the Nasdaq over the past five years. I added the red line to illustrate that one could make the argument that the market is really just about the same place as it was at the start of 2004. Interestingly, throughout most of this period most people believed the U.S. economy was in pretty good shape. Yet many buy-and-hold investors during this period would have struggled to see any significant gains.

 
To me, this helps illustrate the need for active management. During this period the Nasdaq has made significant moves both up and down. Investors and managers who can properly read the market had the potential to make some profits during those periods of volatility. Of course, even better opportunities have occurred in specific market sectors like energy, precious metals, or bonds where periods of longer trends have allowed astute investors to capture better gains.

Considering the significance of the economic obstacles that currently exist, one could argue that the financial markets have held up fairly well. Although the major indices have seen double-digit declines from their recent highs, the losses so far have not been anywhere near as serious as those experienced in 2001 and 2002.

The next intermediate cycle is likely to provide a critical test. If the Nasdaq can hold support at or near this 2,200 level, that will be good news for investors. That should be a sign that the economy is holding its own and we could see a more significant rally before the end of the year. If it breaks below this critical support then a more prolonged slide is likely and we could see major indices end 2008 near their lows for the year.
F.S.

One of the reasons the markets stopped their steep slide is that corporate earnings reports for the second quarter have been coming in and some have been better than expected. Wall Street was especially relieved to see Wells Fargo exceed expectations because the banking sector has been hammered. But it is too early to get excited about these early reports. The majority to companies have yet to provide information about their second quarter performance and many are likely to have been hurt by rising costs.

Of the many economic fundamentals that impact the financial markets, perhaps the most important are consumer confidence and consumer spending. Consumer spending is the engine that drives the U.S. economy. And while consumer spending rose in June, most of that was attributable to tax rebate checks.

The latest Consumer Confidence Index released at the end of June by the Conference Board showed the fifth lowest reading ever. It seems unlikely that consumers will gain much optimism until prices moderate and home values stabilize. The next Consumer Confidence Index reading will be announced July 29, but there is no reason to anticipate a significant increase. Here is the link for the most recent report: http://www.conference-board.org/economics/ConsumerConfidence.cfm

My best guess would be that this latest move is just a short-term bounce and that stocks will resume their downtrend soon. The chart below shows Nasdaq price movement over the past year. You can see that this latest downward move ended at the same level as in March. I added two lines to the chart to show where I think it is most likely that this advance will peak. The gold line on the top chart is a 50-day moving average. I suspect the Nasdaq will advance back to its 50-day moving average but fail to penetrate it, which means the advance will stall at about the level marked by the green line. If it somehow manages to break through that level, it would meet strong technical resistance at the level marked by the blue line–where it peaked in May and early June.

The bottom portion of the chart is a Moving Average Convergence Divergence (MACD). Notice that the MACD has begun to move upward. In a normal cycle it should reach overbought levels about the end of August. Obviously there is no guarantee that the cycle will be normal. But right now there is nothing technically or fundamentally to indicate that the market is on the verge of a sustained advance.

We’re officially at the mid-point of the summer season. I hope you are making the most of this wonderful time of year.

F.S.

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