Talking Trading: Bear Market?

This past Friday saw the worst one-day drop in the markets in about 3 years. The Dow was down over 200 points, erasing all the gains of 2006 to date. Not a good way to start off the year.

What's interesting to me is the wide variety of reasons I've heard given for Friday's plunge. Most of the talk on Friday itself surrounded either concerns about Iran's possible nuclear weapons program, or the higher price of oil. (Granted, the Iran situation would naturally cause oil to rally, thus pressuring the equities markets, so these two concerns are more than casually related.) As the weekend progressed though, I started hearing more mention of things like the inverted yield curve again, or the big decline in housing starts, or even inflation. Others, like me, were more focused on the string of bad earnings reports from major companies like Intel, GE, Apple, Alcoa, et al.

What's striking isn't that people can't decide what's causing the selloff. No, what we should be worried about is that there are so many bearish indicators and events that are all popping up at the exact same time. While inflation or Iran alone aren't enough to cause a recession, the combinaion of all these things should cause more than a little bit of worry. Especially when one considers that housing has been the primary driver for the economy for the past several years. Add to the mix the fact that home equity loans are shrinking fast, and we have a real issue on our hands. Consider also that both housing starts and corporate earnings are leading indicators. I'll be watching the next few weeks of employment data very carefully - if jobless claims start rising again, I'd expect to see GDP growth level off and maybe even start to decline by the second quarter.

Of course, if the economy does start to cool off, what should we do to protect our investments? First off, inklings of recession are a great signal to take stock profits off the table. That's an obvious one. Usually, the best move is to roll into the bond market, since the Fed typically cuts rates in order to try and kick-start the economy. (Note, Greenspan's tenure as Fed chief has reached it's final few days, and nobody really knows how Bernanke will proceed. However, there's already a lot of speculation that Bernanke will, at the very least, stop raising rates within the next few months.) The only problem with the bond market right now is that it's already pretty high, since overseas investors, primarily from Asia, have been buying up our long-term debt with seemingly endless voracity. While it may be a safer bet than equities in general, you're not going to get rich buying bonds at these levels.

One interesting possibility, however, is to increase holdings in foreign securities, either debt or equities. In theory, if the US economy starts to slow, the dollar will weaken. Assuming that foreign countries do not experience as severe a slowdown, one could profit by buying foreign stocks, waiting for the dollar to weaken, and then convert back into US currency, taking advantage of both the forex play and, hopefully, decent returns on the stocks in general.

Keep in mind - it's hard enough to find a decent stock to buy in this country. Trying to do the research to find a solid company overseas, where accounting rules may differ, local laws certainly will not be the same, and finanical statements may not be written in English, can be extremely difficult. Not to mention, it's neither easy nor cheap to directly invest in many foreign countries. Perhaps a few closed end funds or country ETFs would be the best solution.