Wrestling With a Bear? Maybe Not, but It's a Good Time to Plan - TheStreet

What would you call this kind of a market?

  • The tech-heavy Nasdaq is again testing the May lows.
  • The big old Dow looks pretty ill too.
  • The old-economy-laden New York Stock Exchange Composite Index, which never participated in the 1999 rally, is back down to where it was 18 months ago.
  • So is the S&P 500 index.
  • Since Labor Day, the most effervescent "new" tech stocks, like Broadcom (BRCM) and Juniper Networks (JNPR) - Get Report, are flat to down.
  • "Old" tech greats like Microsoft (MSFT) - Get Report have slipped to new lows not seen in two years.
  • Semiconductor maker Micron Technology (MU) - Get Report just hit yet another new low for the year.
  • Nontech companies like AT&T (T) - Get Report are at depths not seen in three years.
  • The Russell 2000 index of small companies is back where it was a year ago.
  • Dot-coms like Yahoo! (YHOO) are collapsing.

On Wall Street, they call this a bull market.

Yes, according to the sell-side strategists, we are not in a bear market. They say that this is simply a market in transition from an era of 20% annual returns to a period of 10% returns. Many smart folks, like my friend and colleague

Jim Cramer

, see the recent market slide as a buying

opportunity within a longer-term bull market. In short, they say, we are unlikely to see a sustained decline in stock prices from current levels.

It is certainly possible for the market to rally from current levels, as the strategists say they expect. But what if they are wrong, and we are staring a grizzly in the face, and we don't know it? If you charge ahead in full bull-market tallyho, you could be mauled.

Even on Wall Street, where risk normally brings reward, there are times when it pays to take fewer risks than normal. Think about it this way. If there is a 50-50 chance that we are in a bear market and you take some money off the table, you may save yourself a fair amount of money and still have buying power for when great stocks are being given away. Worst case is that the market rallies back above, say, pre-Labor Day levels, and your gains lag the market averages.

Why fear a bear?

The first thing that makes me smell one -- You ever smelled a bear? Yikes! -- is the market action of the past year. The market leaders -- technology stocks -- were dramatically

overbought

from October of last year to March of this year. They are now in the process of being

oversold

. They do that in bear markets.

My second worry is more fundamental. The uniquely benign conditions that led to the great bull market of recent years are over. It was a virtual petri dish for creating the King Kong of all bull markets. The Cold War was freshly over, and peace reigned in all the major nations of the world. The global economy kept humming through thick and thin. Inflation was nonexistent. Earnings were great and growing. Interest rates were lower. A flood of new money came into the market.

Third, have you looked at the chart of the Dow recently?

Dandruff Protection, Not Investor Protection
The Dow's head-and-shoulders pattern emerges in this chart

I'm no technician, but the Dow has taken on a classic head-and-shoulders formation in the past year and a half. (One professional investor I know refers to this as a "circus formation," as in a "big top.") The left shoulder was formed last year. The head was made in January when investors ramped the Dow stocks. The right shoulder formed about six weeks ago. My concern? When head-and-shoulder formations break, the right shoulder -- i.e., what's to come -- tends to take on the same shape as the left shoulder. If the Dow did that, we could be looking at Dow 7700! If we get Dow 7700, where do you think the other averages might go? Not up.

Another index I like to follow is the

RLX

,

Standard & Poor's

retail stock index. It looks like an ad for shampoo, too. At the very least, it signals a struggling consumer, which is not great news for the economy or company earnings.

Blue-Light Not-So-Special
The S&P Retail Index signals a slowing consumer

Fourth, big investors remain extremely bullish. According to

International Strategy & Investment's

survey of institutional equity managers, the big pension funds and endowments remain more bullish on stocks than at anytime in the past six years, with the exception of two months ago. That means a lot of selling if they ever revert to more normal levels of bullishness. You can argue that many mutual funds will never again be anything less than fully invested in stocks, that they will simply rotate from one market sector to another. Do you really want to make that assumption with your money.

Fifth, we are heading into the first year of a new presidential term no matter who wins next month. Maybe I have spent too much time in Washington, but that sets off my alarm bells. A new administration has one overriding objective -- to get re-elected four years hence. The traditional way to ensure that is to take the painful hits as early in the term as possible. Clear the economic decks in 2001 so that you can win politically in 2004. In short, take a recession sooner rather than later. Not good for stocks.

So what should you do other than go to cash? I'd suggest putting some money in the sectors already working pretty well in a lousy market. Look at the oils and the drugs and the consumer staples. Some oils, for the moment at least, offer real earnings momentum. Did you know that

Valero Energy

(VLO) - Get Report

just reported third-quarter earnings of $2.01 a share vs. 40 cents a year ago. Now that is earnings mo! The stock at $33.50 trades at about four times earnings if you assume they can earn two bucks a share each quarter for the next year.

I do not mean to scare anybody. I simply want you to think about the downside before we all get overexcited when the market goes lower. If you decide this notion is hokum -- and perhaps it is -- at least you re-examined your assumptions. If you agree with me that there is a 50-50 chance of a bear market, then you know now to take defensive steps. Either way, you are none the poorer.