Are We in a Correction or a Bear Market?


dolphin

This is actually a repeat from a post I made about five years ago – the last time we saw a big correction.  Once again, however, we’re seeing people misuse the terms correction and bear market.  My readers are better than a bunch of financial reporters who just parrot the wrong definition they heard.  Here’s what the true definitions of a correction and a bear market are, so you can use the term correctly:

Please allow me to address a pet peeve of mine today.  That is the correct definition of a correction and a bear market.  It wouldn’t bother me so much if just the nightly newscasts got this wrong, but I hear people who should know better such as the Wall Street Journal getting it wrong as well.  Please refer your friends to this post and distribute it far and wide for I’d like to stop hearing people incorrectly using these terms.

First of all, the incorrect definitions.

Often on a newscast during a market downturn someone — either the anchor or the person they are interviewing — will say we’re having a correction, but have not yet entered a bear market.  They then will present the usual, incorrect definition that a correction is when the market has gone down 10%, and a bear market is when it has gone down 20%.  While it is true that the market will tend to decline more during a bear market than during a correction, the correct definition has nothing to do with percentages.  (This is like the old joke that a recession is when people are out of work, but a depression is when you’re out of work!)

To understand the correct definition, one must understand a little about charting, trends and Dow Theory.  For some basic definitions see the past post on charting: https://smallivy.wordpress.com/category/charting/ .  Corrections and bear markets have to do with what kind of trend the market is in. Specifically the long-term trend, which is found using a chart with intervals of a week making up each point in the chart.  Normally a Open-High-Low-Close chart would be used in which the opening price, high price, low price, and closing price for the week would be plotted for each point.  For an example, see the chart for Harley-Davidson during the 2009-2010 period:

http://finance.yahoo.com/q/bc?s=HOG&t=6m&l=on&z=m&q=b&c=

A stock is in an up-trend if the stock is making higher highs and higher lows, such that a straight edge can be laid on the chart and a line drawn from low to low and the stock does not cross this line.  This is known as the trend line.  Harley was in an up-trend from mid-February to mid-May of 2010, and as one can see the lows followed the trend line pretty well, such that each time the stock’s price fell to the trend line it bounced off of it and moved higher.  A down-trend is just the opposite, where the stock sees lower lows and lower highs, such that a straight edge could be used to connect the highs in a descending trend line.  A stock will be in an up-trend, a down-trend, or drawing lines (bouncing between two prices and going nowhere) at any given time.

In order for the trend to change, three things need to happen.  For an up-trend:  1) The stock’s price must break the trend line.  2) The stock must fall below the previous low, and 3) The stock must not reach the previous high.  For Harley the trend line was broken in early May, the low was broken in mid-May, and the stock failed to reach the previous high later in mid-may, so the stock has reversed from an up-trend to a down-trend (like much of the market in 2010).  One could now form a down-trend by connecting the high reached in early May to the lower high reached in mid-May.

Dow Theory looks at the Industrials (the DJIA) and the transportations (the DJ Transportation Index).  Each time both of these move down in price (one of the regular downward movements as was seen in the Harley chart) while they are in an up-trend — a Bull Market — it is called a correction.  If they both actually change from an up-trend to a down-trend, we are in a bear market.  For Harley, it was in a bull trend from February until May, with corrections about once or twice a month.  In late May 2010 it entered a bear trend and went all of the way down to $10 before correcting and turning into a bull trend.

I’ve heard that the incorrect definition came from someone one of the shows was interviewing who didn’t want to go into Dow theory, so he just gave the 10%, 20% definitions, probably in a statement like, “If it is just a correction, we may see a decline of 10% or so.  If it is a bear market it may go down 20% or more.”  Because a correction only requires one down-leg before the stock climbs to a new high, while a bear market by definition requires at least two down-legs, most bear markets will result in a decline of about twice that seen during most corrections.  Likewise, a correction of less than about 10% probably would be barely noticed, so the trader was probably just trying to get the relative magnitudes across, not knowing that his rules-of-thumb would become gospel.

Corrections can be much larger, however.  An extreme example is the crash of 1987, which now just looks like a small blip on the chart of the DJIA.

http://finance.yahoo.com/echarts?s=%5EDJI#symbol=%5EDJI;range=my;compare=

In that stunning crash the Dow Jones Industrials went from 2596 to 1938 in one day — a decline of more than 20%!  Looking at the chart, however, you’ll note there was only one leg down, the trend was never broken, and the spectacular bull market that started back in the early ’80’s under Reagan continued clear until the early 2000’s when it was finally ended by the dot-com bust.  Since that time we have been drawing lines.

So, you now know the correct definitions, so please stop spreading the incorrect ones.  Also, forward a link to this post to all of your friends to correct the mis-information.  I’ll know my quest is done when I see USA Today with the correct definition.

.

Got and investing question? Please send it to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

DON’T PANIC!!!!


 

Fish
Don’t Panic!  Any fan of the Hitchhiker’s Guide to the Galaxy knows that those calming words are scrolled across the face of the Hitchhiker’s guide to bring comfort to the user.  They should really be scrolled across the top of your screen when looking at your brokerage account statements this week, because panicking is the worst thing you can do when the market goes into a tail spin.
Panicking makes you sell stocks at the bottom, or try to do fancy things like selling stocks short or buying options in an effort to protect your portfolio that often just end up making you lose more money.  It’s really our nature to try to do something, but just like it is usually the best thing to let go of the wheel and take your foot off of the gas and brake when your car goes into a spin on a patch of ice, sometimes the best thing to do when investing and the market goes into a free fall is to just let things go and wait for things to settle.
Things to know about market drops:

The losses from many sell-offs will be largely or fully regained within a year.

If you look back at some of the big sell-offs, such as the 2008 fall and the 1987 drop, you’ll see that the prices of stocks had largely recovered by about a year later.  If you can simply stay put and wait, things usually get better.

The crowd is almost always wrong, so when people are selling, it might be a time to buy.

If you can add money during a fall, you can come away in better shape than you started.  You’ll probably miss the timing, so expect the market to continue to drop as you buy for a while.  This is called “trying to catch a falling knife,” which is just as tricky as it sounds, so don’t expect to catch the bottom.  Just buy in, raise some more cash, and then buy more.  Also, spread your investments around a bit since some segments of the markets will recover before others.
Even when you see sell-offs coming, figuring out exactly when they will occur is nearly impossible.
It is easy to see when the market is overvalued and ready for a fall, but that doesn’t mean it won’t continue to rise for a couple of years after that.  Accept the fact that you can’t time the market.  Buy regularly when you have many years before you need the money.  Sell and raise the cash you’ll need within a few years regardless of market conditions.
Some sell-offs are very short and then resume the climb.
Before a real sell-off to end a bull market, there may be false starts.  Sometimes stocks will fall, only to rebound when the news comes out indicating that the Fed isn’t going to raise rates or something.  If you panic and sell, you may end up buying back in at higher prices, only to see the market actually fall at that point.
Once a sell-off is complete, it will probably be the best buying opportunity you will have for years.
At the start of 2009, there were many great companies that had their share prices in the single digits that are above $50 now.  Market sell-offs are great things when you still have many years to invest.  Take advantage of big bull markets when you’re starting to get to the time in life when you’ll need the money to raise the cash you need.  Take advantage of market drops to accumulate shares when you won’t need the money for several years.
Hey, I sure don’t know it all.  Help make this site better by leaving a comment!

Got and investing question? Please send it to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Going to Bars to Drink is Foolish


 

MushroomsMoney had an article called Here’s How Rich You’d Be if You Stopped Drinking that peaked my interest last weekend.  I thought that maybe they were going to look at what investing the cost of what people are spending on alcohol would do over your lifetime.  Instead they focused on the cost of drinks and food at bars and suggested things like drinking and eating before you go out to the bars and then only getting a drink or two.  I’m not sure telling people to drink before they go out and drink more is such a good idea.  Really, having more than one or two drinks in public is not a good idea at anytime since it leads to bad decisions and possibly the police station as either an inmate or a victim.

What the article really should have said is that using bars to drink is a dumb idea.  If you walk into a bar and drink for the sole purpose of getting a drink, you’re being financially foolish.  You can get the same alcohol that they are serving for maybe a quarter of the price at the store.  You can make your own wine or beer for about one eighth of the cost of a drink at a bar.

If you go to a bar, you are paying for the atmosphere.  You should be there to watch the game on a TV you don’t have at home or with a group of friends.  You should be there to spend some time with a friend or a date.  You should be there to get drinks you can’t get from the corner store (for example, brew houses).  You should be there for entertainment such as live music.  It should be worth your money.

Given how many sad, pathetic bars there are in the world, I’m guessing that many people don’t follow this advice.  There are too many dirty, dingy, run-down bars with nothing but some tables and some neon that are still in business.  Hopefully people will start demanding more from bars by voting with their pocketbooks.  Coffee at coffee houses is way overpriced as well, but at least they are able to make coffee drinks you can’t buy at the corner store or make at home.  Why should bars be any different?

Comments?  Questions? Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get notified of new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

The Role Income Stocks and Bonds Play in a Portfolio


farmhouseIncome stocks and other assets have a place in your portfolio during certain stages of your life, generally when you need income or stability. Income stocks are more stable than growth stocks because their return is more certain. The markets may stagnate, causing returns from appreciation to be very low or even negative for the year. Because income stocks pay a steady dividend, however, you can get a return on your investment even when the markets are going nowhere. The time when this makes the most difference is when we have a long period – maybe 3-5 years– where the markets really go nowhere. Holding income stocks will put you ahead of the game when the markets do finally turn around.

Another reason for holding income stocks is just what the name implies: income. If you need income for expenses, it’s nice to have a dividend paid out four times a year, or interest from a bond paid out twice a year. If your portfolio is large enough and interest rates are high enough, you can setup a portfolio of income stocks and bonds such that you have the money in your money market account right when you need it for your yearly expenses. You just stagger the dividend and interest payments to receive income when you need it based on your bills.

Normally you would use a portfolio of income stocks if you were in retirement. It can be used for other purposes, however. For example, if you had a son or daughter going off to college, you could send them with a portfolio of income stocks and bonds designed to provide the money needed when tuition bills and other expenses were due. If necessary (because the portfolio wasn’t large enough to sustain itself) they could also sell off some shares as needed to generate additional income. When they were ready to graduate, they could use whatever was left over of the money you gave as a starter portfolio, an emergency fund, and probably a down-payment on a house. Note that you would need to start building up this portfolio when they were 15 or 16 by starting an account for them and transferring funds and stocks into it since you would be limited to how much you could transfer without paying gift taxes.

Creating a portfolio for your children is often better from a tax-standpoint, but you also might have a child that spends all of the money you’ve set aside for college on other things. After they turn 18, the portfolio becomes theirs and they can do what they choose. Another option would therefore be to buy income stocks and bonds in your portfolio and use income from them to pay tuition and living expenses for them directly. You could also do something like provide a couple of year’s worth of expenses in a portfolio for them, then continue to add to it if they handle their money wisely. The chances of being able to pay for things from income from the portfolio alone in that case, however, would be low since the account value would be smaller.

A final reason for holding income stocks is to reduce the risk of a serious loss. Basically, you have grown your portfolio to a certain point and want to avoid suffering a major setback. Because the dividend payments tend to support the price of income stocks, and because bonds eventually are repaid by the company if they are still in business when the bonds come due, income stocks and bonds are safer that growth stocks. It isn’t a bad idea to put a portion of your portfolio into income as you make some sizable gains and want to protect them.

Income stocks and bonds are not the best choice when you’re young and trying to grow money. The returns will be lower over long periods of time for a basket of income stocks than that from a basket of growth stocks, plus you’ll be paying taxes on the income each year. If you do want to hold bonds and income stocks before you need the income and just reinvest, because, perhaps, you are willing to sacrifice return for fewer fluctuations in the value of your portfolio, it would be wise to put them into and IRA or a 401k where they would be sheltered from taxes and keep mainly growth stocks in your taxable portfolio.

Comments?  Got and investing question? Please send it to vtsioriginal@yahoo.com or leave a comment.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Sold My Shares of Oasis Petroleum Today


After holding them for about a year, I sold my last shares of Oasis Petroleum today.  Normally I’m fairly reluctant to sell shares of stock after I have bought them.   I generally ignore the price of the shares after I’ve fully established a position since it really doesn’t matter so long as the company is doing well.  In this case, however, I decided that things had changed fundamentally with the company; therefore, it was time to sell.

I bought the stock at probably the worst time – right near the top.  I bought the shares for two reasons:  1) I wanted a hedge against inflation in energy prices. Buying an oil producer fit this bill.  2) I thought that there was room for growth since the company is fairly small and drilling in the Dakotas where they are just starting to tap the resources.

Unfortunately, the Saudis had a different plan.  Because of high oil prices, America started developing oil fields that they hadn’t in the past.  The development of the hydraulic fracturing, or fracking method, allowed oil to be extracted from wells long since abandoned.  Suddenly the combination of high oil prices and new technologies caused an American oil boom where the US was producing enough oil to meet all of its needs for the first time in a long time.

Saudi Arabia and the other OPEC countries realized that the high price of oil were causing their grip on world oil markets to fade.  They therefore decided to flood the world with oil and drive down prices.  This in turn made it unprofitable to extract oil by fracking.  This will cause the oil frackers to go out of business.  They could start up again if oil prices rose enough, but because of the high start-up costs, one or two restarts would drain the companies of resources.  The OPEC nations know that as long as they keep oil prices relatively low, they’ll own the markets.

And that is where Oasis Petroleum comes in.  Because they are a company fracking for oil in the Dakotas, they were greatly affected as the price of oil dropped.  While I would normally hold and just wait for the recovery, I realized that the fundamentals of their business had changed and it was time to get out.

I can take a little comfort in knowing that I can deduct the loss against a gain on another stock.  I may do this if I have a large gain where the position gets so large that I need to trim it back a little.  I can also deduct a portion of the loss against my salary for next year.

Another reason to sell is that I can now put the remaining money into something more profitable.  Sometime you just choose wrong – that’s part of investing.  When that happens, you need to take your losses and move on.  Just remember that one great stock can make up for several bad ones.
Got and investing question? Please send it to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

How to Identify a Growth Stock


dolphinAs discussed in the last post, growth stocks are stock in companies that are growing rapidly.  They tend to be young companies, or companies that have gone through a serious contraction to the point where they are small again.  Growth company stocks will provide the greatest return over long periods of time, but will also provide the most unpredictable returns.  They are therefore mainly what you want to own if you’re investing for decades, but not what you want to buy if you have only a year or two or really, really need the money at some near point in the future.  401k fund at 20?  Yes.  College fund when the kid is 16?  Probably not.

So that question then becomes: how do you find these growth stocks?  One of the easiest things to do, and really what you are forced to do in most 401k accounts, is to buy a growth fund.  Most funds that specialize in growth stocks will have the word “growth” in their name.  If not, the fund’s prospectus will have a diagram with little boxes showing whether it is value, growth, or a blend (a combination of both).  Like everything, in general if you have a choice you’ll do best buying the fund with the lowest expense ratio.  (Think index fund or ETF.)  When comparing you should also check the size of the stocks in the fund, however, so that you compare funds that are both large cap growth, for example, instead of one that is large cap growth to one that is small cap growth.  Again, look at the little diagram in the prospectus.

Finding individual stocks that are growth stocks — which is one of the criteria for what I would call serious investing stocks — requires a little more work, but not that much.  Once again, you are looking for stocks that are small enough that they have the ability to grow, but also which have shown that they are well-managed and actually will grow.  Some stocks start small and stay small, if they stay around at all.  Things to look for are:

  1.  Earnings are growing regularly at a sustainable pace.  I like stocks with earnings growth in the 10-20% range.
2.  The company has room to grow.  If there is one on every corner, how can it grow?  Many growth stocks will not be household names.  Maybe find a company that is only in your area, or not in your area at all.
3.  The stock price increases regularly.  Some of the best stocks are found by looking at the price graphs.  Look for one that you could lay a ruler across the ten-year chart and have it nearly follow the ruler.  Steady growth is what you want.
4.  No dividend.  Normally a dividend is a good sign, but if a company is paying a dividend, especially a big dividend, it isn’t putting all available resources into growth.  You want no dividend today so that the company can pay a bigger dividend tomorrow.
5.  Small or medium market cap.  You want a stock with a market capitalization, defined as the number of shares times the price of the stock, in the tens to hundreds of millions, not the billions of dollars.  Again, you want room to grow.

Got and investing question? Please send it to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Why Young People Should Buy Mainly Growth Stocks


cowIn what I call serious investing, the main type of stocks that would be purchased when one is young, loosely defined as age 12 to maybe 45, would be growth stocks. These are stocks of companies that have room to grow and expand. The reason that these are the stocks to own while you are young is that they will provide the greatest return provided you have a long time to hold them.

Think of it this way: Let’s say you own a business that sells roses at a subway stop. Everyday you could expect to sell a certain number of flowers to people coming through. It would be different people most days, but on average you would sell a certain amount, to the point that after a few weeks you would know how many to bring to avoid having a lot left over. There would be periods, of course, like Valentine’s day and Mother’s day season where you would sell more. You might also sell more in the spring since that is when people are thinking of flowers and because there are a lot of people starting to date in the spring. Those changes in sales would be predictable after a few years of selling and would just become part of your expected income for the year.

The amount of money you would be taking home would be fairly constant. There might be sometimes when you are able to find flowers for lower prices and then maybe make a little more. There might also be changes in the population a little, where there are more people coming through the subway and therefore you end up selling more roses, but in general the amount of income you would take home would be fairly constant. This would be comforting in a way because it was predictable. You would know that you would have enough money to pay your rent and put food on the table because you had been able to do so every month. Maybe you would save money from the months where sales were particularly high, or use those months to pay for the bills that come up less often, like insurance and vacations, since the income in the other months would not be enough.

While your reliable income would be nice, the amount of income you could get by taking a few more risks would be greater. Assuming you had a reasonable number of competitors, such that people could go elsewhere to buy flowers if you started charging too much, you would be lucky to make more than a few percent of profit. This limits the amount you can make. If you were to expand your business line, maybe selling potted plants in addition to roses, or starting a delivery service to offices nearby, or setting up stands in other subway stations, you could grow your revenues and profits by more than you could through simple change in population and efficiencies alone.

To grow and expand your business you would be taking on more risk, however, and you would have some failures. You might spend a lot of time setting up a flower stand in another subway station, only to discover that people there like tulips instead of roses. You might find that office deliveries result in a lot of flowers being damaged, adding to your costs. You would also need to take on additional workers which comes with its own costs and unknowns.

You would know that with time you would find things that worked and caused your profits to grow. You might see your profits drop one year because you were spending more money expanding the business, but in future years those expansions would add to your profits. The risks you were taking would reduce the ability to make predictable profits each week. Over long periods of time, however, you could expect profits to increase.

Growth stocks are the same way. They are growing and expanding, meaning that over long periods of time they will provide a greater return than will income stocks that are established businesses with predictable earnings. Because you need to hold them for long periods of time, you need to make sure you have enough time for them to realize the fruits of the investments they are making.

You would not want to put money you need within a year or two into a growth stock because the chances of it being up in a year or two would be about the same as the chances of it being down. If you had 15 years, however, and had the choice between buying three income stocks and buying three growth stocks, you’d be better off with the growth stocks because you would get a better return unless you have really bad luck with your choices. When you are 20 and have 45 or 50 years until retirement, you can afford to put your money into growth stocks and wait for them to mature. In fact, you would be giving up a lot of return if you concentrated in income stocks and bonds instead. You would see fewer fluctuations in the value of your portfolio, but you would also see it grow considerably more slowly.

.

Got and investing question? Please send it to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.