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Advice for Stressed-Out Bears


Diehard, inflexible thinking is bad for your financial health.

As the stock market continues its unsustainable climb, and portfolio values recover from the depths of their devilishly low point of early March (S&P 500 at 666), there's one group that hasn't been enjoying the merriment of late: the bears. Clinging to the ill-advised belief that the end of capitalism was upon us, the flexibility necessary to successful investing was absent 2 months, and seems to remain so (although certain high-profile bears have begun the capitulation dance one usually sees at the end of a move).

The main issue stressing out the bears is that they drank their own end-of-capitalism Kool-aid and were, therefore, on the wrong side of the rally from the get-go. Which makes decision-making now some 35% off the lows that much more difficult - not to mention the psychological hit to the ego. What these die-hard bears will do is exactly what kindred spirits of the opposite persuasion (die-hard bulls) do: stay the course. And in the process, experience the vise-like pressure of an irrational market, which in this case, is to the upside.

The downside to all this is the missed opportunities to exploit the trends in place and their inflection points (when they occur, and however temporary they may seem at the time). With emotions on high, vision then becomes clouded and the best method of investing -- dispassionate thinking -- is supplanted by table-pounding dogmatic thinking. What is, takes a backseat to what should be, as the perfect becomes the enemy of the good. And, in the process, clouds the vision even further. And so it goes.

So, as momentum lemmings and squeezed shorts find ways to justify the unjustifiable, and as talk of economic green shoots propels stocks to overshoot, the bears can take heart that we've entered the zone of high probability of low upside potential. And, just like its mirror-image twin of 2 months ago (only in reverse), the advisable investment strategy is to maintain your equity exposure at a constant rate, then eventually diminish the percentage of your total portfolio in equities as the signs of bullish exhaustion become ever more pronounced.

Investment Strategy Implications

For the record: In accounts that I manage, I've been selling into this rally since last Thursday and will continue to do so to ensure that the percent in stocks remains in the low 90% range. Since I tend to be early at market turns, and despite the fact that the technical analysis indicators I use are flashing increasingly brighter yellow signals (see last week's article Bulls Out of Momentum, as well as my blog posting from Tuesday of this week, Sinko de Mayo), I'll wait to reduce the equity exposure until yellow turns to red (which looks like it could happen within the next few weeks, if not days).

The specific initial action steps taken in accounts managed are to lighten in those areas that I love -- emerging markets -- but have the loudest yellow warning signals and have grown to the largest percentage of the portfolios managed, thanks to being on the right side of that trade. What I'll also do (as yellow turns to red) is further reduce my equity exposure via a hedge of my emerging market bets (in Brazil (EWZ), emerging markets (EEM), and EAFE growth (EFG)) by shorting the most economically challenged area in the world: emerging Europe (GUR).

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As stocks embrace the pending results of stress tests, it looks as though bears need not stress out for much longer. However, my longer-term advice to the bears is this: One-way, die-hard thinking is always stressful. It may make for entertaining television, but it's not good for your financial health.
No positions in stocks mentioned.
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