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  • James Tharin, CFA

What to do if you see a Bear

It’s been well publicized that the month of January 2016 was not the worst January in history for US equities - it was the second worst. The interesting thing though, is how vocal the perma bear community has become - after the fact. There are many bloggers out there who have been ‘telling us so’ since 2009 and they seem to be getting louder after the recent markdown. Some of the prognostications that we have read lately call for a bear market that will dwarf the 2007 to 2009 bear market and there are calls for the price of oil to drop to $16 per barrel. Anything can happen but those types of events are just NOT predictable - period. And it just doesn’t seem logical to think that we will have another Great Recession right after the last one just ended.

Can the current state of US equities morph from a correction into a full blown bear market? You bet it can. But with the information we have today we don’t think the basis exists to say that the bear is in our campsite. We have seen some bears off in the distance though. On January 5th we wrote: “While the Trend and the Fed appear to be questionable, our favorite sentiment indicator shows that the crowd might be getting overly pessimistic which could set the markets up for the next leg up of the secular bull market that started in 2009. Our opinion would change if the S&P takes out the October 2014 lows at 1820.66 – highly unlikely in the near term, in our opinion.” The entire article can be found here: Buy Low Sell High. So far 1820 on the S&P 500 has held on a closing basis although there was a close call on January 20th. Admittedly we were surprised to see our stop loss approached as quickly as it was. But a win is a win. For now we continue to monitor the 1820 level. We are currently sympathetic to the idea of another trip upwards to about 2100 for the S&P 500, even if the ultimate outcome is to be lower lows.

So what’s the plan if the 1820 level does get taken out and we are forced to declare a bearish posture towards equities? First of all, risk management is rule one in both bull markets and in bear markets. Each of the strategies we manage was built upon a solid risk management foundation. For example, in our Global Capital Appreciation and our Tactical Asset Allocation Models we would increase cash levels, monitor market trends and continue to adjust accordingly if conditions deteriorate. In short we manage risk by altering cash levels when certain conditions are present. As of this writing the Global Capital Appreciation Model Portfolio currently holds a 34% cash position and the Tactical Asset Allocation Equity Model currently holds a 41.50% cash position. Our Vanguard Trend Following Model is currently 96% in cash. Hopefully a market rebound will force back into equities.

We believe that risk management can best be achieved for clients that are utilizing our Global Rising Dividend Strategy by holding a portfolio of high quality dividend paying stocks diversified by economic sector and security (we hold 20 stocks in our model). While we might change the sector allocation or security selection in this strategy periodically, we intend to keep it fully invested. Investors in a Quality Rising Dividend Strategy should expect to be compensated to wait for their securities to appreciate with an attractive dividend yield. High quality dividend paying equities have historically proven themselves to be exceptionally resilient and profitable as an asset class over time. The key is to exercise patience – something most individuals have a hard time doing.

We use a highly quantitative model to help us judge risk levels in the stock market. There are currently thirty-six factors used as inputs into the model. Right now the model would indicate that conditions are about as neutral as they get. It bears repeating that the idea is to constantly monitor and adjust while trying maintain equity exposure during the longer term bull trends as the markets present them to us. So if the model changes then our investment posture will change accordingly. But Mr. Market will do everything he can to get you to sell your stocks to him at cheap prices. So the answer to the question for handling the next Bear Market (and the one after that and the one after that…) which absolutely will come one day is to have a solid investment plan and follow it. Now if you don’t have a solid investment plan then by all means, panic and sell everything at the bottom!

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