Stock Trading: Don’t Sit On The Sidelines

Investors are reeling from what has become the worst year on the stock markets for several generations.

We all know the gloomy story.

Before last week’s mini-rally, only 10 stocks in the S&P 500 were in the green for the year and more than 40% of the Russell 3000 was trading below $10 a share. Only Wal-Mart Stores (WMT) was higher for the year in the Dow Jones Industrial Average (^DJI).

The small caps have been getting hit especially hard. Two weeks ago, the Russell 2000 dropped 14% in just two sessions, the worst 2-day loss in its history.

Volatility has been through the roof. Barron’s reported that Goldman Sachs recently told clients that the S&P 500 (^GSPC) 3-month realized volatility was at 66%, surpassing all other volatility levels except that during 1929, when it was at 68%. Goldman apparently expects the volatility index to surpass that dreadful year shortly.

With all this bearish news, it’s logical that most investors believe it’s better to be sitting on the sidelines.

But that would be a mistake.

History has shown that vicious bear markets are followed by big market rallies. If you stay out of the markets, and think you can time when to jump back in, you’re likely going to lose out on much of the rally.

The sustained rallies, which have generally happened within a year of the bottom of the market sell-off, have been huge.

• Great Depression market downturn of Sep 1929 to July 1932: Rebound was 172.2%
• Super Bear market downturn of Jan 1973 to Jan 1974: Rebound was 56%
• Market Crash of Aug 1987 to Oct 1987: Rebound was 35.8%
• Dot-Com Bust Jan 2000 to Oct 2002: Rebound was 36.9%

But what if we’re not at the bottom, you ask?

No one can time the market perfectly. But historically, there are many more years of “up” markets, then down.

Investors are now flocking to the bearish mutual funds in order to get returns. Many of those funds are having a stellar year betting against the markets. But if you look at their longer returns, the story isn’t so rosy.

The Prudent Bear Fund (BEARX) for example, returned 34.50% in the last 3 months. But its long-term return is a different story. It has returned just 0.04% from 12/28/95 through 9/30/08 compared to 6.95% for the S&P 500 and 5.61% for the Nasdaq (^IXIC). How well have investors timed that?

If you’re scared about getting back in, keep in mind that most of the damage has already been done to the markets. As hard as it may seem, investors now need to look at buying- not selling.

Market crashes are once-in-a-lifetime opportunities but you must be invested in equities in order to take advantage of the rally. Just look at last week’s rally. What should have been a “quiet” holiday week turned into the best week on the S&P 500 in 34 years, with the index up 12%.

Sitting on the sidelines may seem safe, but the rewards are few.

Posted in Categories: Contributor, External Research, Stocks, USA.

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