“No rally can be sustained with yields and P/Es so poorly valued,” says underground investor Chris Weber, writing for DailyWealth. Chris is a very special kind of investor. When he was 16 years old, he turned just $650 (saved from his paper route) into $1.8 million through a series of remarkably insightful investments. So naturally we’re all ears when Chris gives his opinion on the direction of the market.

Chris is bearish on US stocks. (He’s mainly in cash and precious metals.) Why? Because there’s no value in the US stock market.

As of the end of July, the dividend yield on the S&P 500 has fallen to only 2.13%. When the rally began in March, the yield was over 3.5%. That is a huge fall in a short time.

Then, as stock prices have soared, earnings of companies have just not kept pace. In many cases, they are down sharply. This imbalance in price to earnings is shown in the weird spike in the P/E ratio on the S&P 500. It is now up to 127 times annual earnings, up from less than 20 times earnings at the rally’s start in March.

In other words, the dividend yield and the P/Es were not what you see at real bottoms. In really low markets, investors are shaken so much that years are required for them to regain bullishness.

Instead, I think what we’ve been seeing are the types of violent rallies within bear markets we saw throughout both the 1930s and the 60s-early 70s.

So once again, I’m just watching the stock markets. My position is that if the Dow Industrials and Transports can both better their previous record highs that they reached back in the second half of 2007, then I’ll be interested and ready to say that we are really off to the races again.

What I think is more likely is a repeat of the period of 1966 to 1975, where we’ll see a series of rallies within a bear market. In other words, this will be an easy time to lose money, and a hard time to make it.

Porter Stansberry has another take on stocks. He reckons we’re in the early stages of a “massive inflation.” Porter’s argument is simple. As long as the government keeps printing up trillions of dollars a year and holding short-term rates at nearly 0%, financial stocks are going to rise… And as long as financial stocks rise, the rest of market will follow.

Financial stocks are on a roll, as you can plainly see from the nearby chart of the financial sector ETF (XLF). Now, ask yourself a very simple question: Are investors buying financials because of their strong balance sheets and smart management or are they buying because they know that the government intends to keep pumping money into these boated behemoths?

Say what you like, US stocks are rising. All we know is we don’t like it one little bit. And we wouldn’t touch stocks knowing what we do about the market. As Chris Weber says, “This will be an easy time to lose money, and a hard time to make it.” Amen to that.

So today we turn away from the markets and focus on something more important: basic investment principles. As Alexander Green, investment director of The Oxford Club, puts it over at InvestmentU.com, “It’s not uncommon to run into investors who are knee deep in option trading, currencies, short selling, or sophisticated arbitrage strategies without mastering – or even understanding – basic investment principles.”

Here’s what Alex believes are the six factors that determine the value of your portfolio’s. Only one of these six factors is beyond your control: your assets’ annual compounded return. That means it only makes sense to focus on the other five.

1. The amount of money you save. To put it bluntly you have to start by maximizing your income, minimizing your outgoing and paying yourself first. Why? Because expenses always rise to meet the income available. As soon as you get a raise or a higher paying job, you’ll find that you need a new car, a bigger house, better furniture and a new set of Callaway irons. But you have to draw the line somewhere. You can’t save a pittance and expect your portfolio to perform miracles each year.

2. The length of time your money compounds. The sooner you start investing the better. And the longer you leave it alone the better. If you start too late – or raid your portfolio to redo the kitchen or take the kids to Disney – you’re going to have a lot of catching up to do down the road. The old chestnut is true: Don’t touch your capital. It’s like eating your seed corn.

3. Your asset allocation. Studies consistently show that how you divide your portfolio among non-correlated assets – stocks, bonds, real estate investment trusts, precious metals, etc. – determines 90% of your portfolio’s long-term return. (The rest is due to security selection.) If you’re too conservative – or too aggressive to stick with your program – you simply won’t meet your goals.

4. Your assets’ annual return. This, of course, is the great unknown. Not even Warren Buffett or Ben Bernanke can say what their portfolio will return each year. But the better your security selection and asset allocation decisions, the higher your annual compounded returns.

5. What you pay in expenses. Don’t be oblivious to what all those financial intermediaries are charging you. You can sacrifice far too much in commissions, bid/ask spreads, wrap fees, management expenses and other costs. All things being equal, the lower your expenses the higher your net returns.

6. How much you pay in taxes. Too many investors are oblivious to the tax ramifications of their investment moves. When possible, put your high-yielding investments in your tax-deferred accounts and your tax-efficient funds and individual stocks in your non-retirement accounts. (I call this your asset location strategy.) Hold positions 12 months or more to qualify for the lower long-term capital gains tax rate. Offset your capital gains with capital losses if possible.

You see what most investors don’t understand (and probably never will) is that market timing and stock picking make up only a small part of serious wealth building. It’s a secret the “ultra wealthy” have known for a long time. And they spend a lot of time and money making sure these six factors are right (and others, too, that would be too complicated to explain here). It’s how they hold onto their wealth for generations.

It’s actually what we’ve been working on while here in France. Along with my dad and your Notes co-editor, Chris Hunter, we’ve been researching these wealth preservation secrets. And we’ve discovered that wealthy families nearly always have something called a “family office.”

Most of these require massive amounts of cash to join. (One group in London my dad went to talk to was looking for a $200 million minimum!) So that’s why we decided to set up Bonner & Partners Family Office. It puts all of the money management secrets of the ultra wealthy to work… without the massive price tag.

Partners will enjoy the following benefits:

Access to what my family is doing with its money. Over the years we’ve spent literally hundreds of thousands of dollars on high-level wealth management advice. It’s been distilled into our family portfolio, which partners will have full access to.

Twice-daily market advice from full-time money manager Simon Mellon. The family has spent a lot of money, and considerable time, finding the right investment director for the family office. Simon has a resume as long as your arm. And his insight into the market is the kind that comes only with years in the trenches in New York and London.

Full-time tax planning advice from Raife Nueman. Raife went to university with your editor at St John’s College. And he’s one of the brightest attorneys we ever come across. (He has been elbow deep in the US tax code over the past two months, and he’s identified a way to drastically reduce your tax spend – to as much as 0% in some cases.)

Access to all of Agora trading advice and investment research. Family office partners will have full access to the entire daily output of Agora, the family publishing company. This amounts to 34 trading and investment research services. (A total of over $97,000 worth of subscription services a year.)

We will be sending out an invitation to join us as a family office partner this week. As a Notes reader, you can join the invitation list early by sending an email to info@contrarianprofits.com. Just make sure to put “Family Office” in the subject line so our staff will be able to quickly add you to the list before the invitation goes out…

1) We don’t like the smell of fish. This rally began with a ‘leaked’ memo from Citigroup announcing a return to profitability and was given legs by banks’ bogus quarterly earnings. Washington has added to the stench with its fudge tests for banks, its PPIP proposal and its active campaigning to relax mark-to-market accounting rules.

2) Much of the buying was caused by short sellers covering their positions (a massive “short squeeze”).

3) “Junk” stocks have been leading the rally. The real winners have been beaten-down stocks with the riskiest outlooks. They generally have had the highest level of debt and the lowest return on equity.

4) Historically, sucker’s rallies are the norm, not the exception. Sharp crashes are often followed by sharp, but short lived, bear market rallies. The 2000–2002 bear market had three, with the Dow gaining an average of 21%. The 1929 to 1932 bear had six, with an average gain of 47 per cent. Even the poor Japanese have suffered their head fakes. The Nikkei has seen about 14 false downs since it crashed in 1991.

5) Generally, bottoms don’t feel like this. Bear markets typically end with a whimper rather than a bang. A recent study by Hussman Econometrics analysed numerous US market bottoms and bear market rallies. It revealed that, with the exception of the 1987 crash, the month before the lowest point of a downturn saw a gradual descent.

6) Stocks are still too expensive. As Yale University professor Robert Shiller says, all four big bubbles of the 20th century troughed at between 5 and 8 times earnings. Stocks did not even fall below 11 times earnings in the recent low.

7) Insiders have been selling the rally. According to TrimTabs, April saw the lowest level of insider buying ever recorded, with insider selling 14 times as high. And companies sold 64% more shares than they bought.

Sentiment isn’t low enough yet for our taste. As Russell Napier says in Anatomy of a Bear , “For the great bear market bottoms, you need a society-wide revulsion with equities. It just doesn’t smell like the big one yet.”

9) The risk of corporate bond defaults is at highs unseen since the Great Depression. Moody’s expects the corporate default rate in the US to reach 14.6% by year end – a near doubling from the first quarter’s default rate of 7.4%.

10) Corporate earnings continue to suffer. Earnings weren’t as bad as expected last quarter. But they are expected to continue to decline until sometime next year.

11) The S&P 500 remains under its 20-month moving average. Every sustainable bull market has been marked by the S&P rising above its 20 month average.

Suffice it to say, we’re sticking to our guns. As Merrill Lynch economist David Rosenberg recently counseled, “For those that missed the big nine-week move, don’t worry. Be patient. The story was right – the tortoise always wins the race.”

After all, most mutual funds, exchange-traded funds (ETFs) and managed accounts offer long-only strategies. And why not? After all, the strategy is simple: These portfolio managers buy securities and hope to take advantage of price appreciation.

But the ongoing financial crisis proved those investors wrong – for several reasons. After all, what do you do in a trendless (sideways) market? And what about a declining market?

In either situation, the profit payoff from a purely long portfolio doesn’t figure to be very large. And that’s no surprise. After all, when bear markets arrive – as they periodically do – long-only money managers are typically limited to raising additional cash, or seeking conservative investments with limited downside, meaning the upside potential is also fairly small. And as investors have seen all too often during the current financial crisis, money managers who insist on “fighting the tape” can often generate big losses for their clients.

That’s where long-short investing strategies come into play.

If the markets head up or down, you’re positioned to profit. And given the wild volatility we’ve witnessed in the last year, any investor not playing both sides of the market, simultaneously, quite frankly, deserves it if they drown their portfolio.”

Unfortunately, many investors have learned their lessons the hard way for the past year and a half as virtually all classes have declined in value, resulting in sizable losses within their portfolios.

“This environment has exposed the flaws in traditional asset allocation theory, Capital Asset Pricing Model (CAPM), or whatever label you choose to put on it,” said Tom Samuels, managing partner of Houston-based Palantir Capital Management Ltd. and manager of the Palantir Fund, a global all-cap long-short mutual fund. “While Markowitz (Harry) and Sharpe (William) still have their firm believers, sophisticated investors are realizing that they cannot achieve true diversification merely by being long a variety of asset classes.”

Samuels believes the majority of long-only returns are influenced by the direction of the overall markets and that long-short investing strategies provide one of the few ways to achieve true portfolio diversification and risk control.

“Long-short represents the only asset class that can effectively handle both sideways and bear markets,” Samuels said. “The asset class allows investors an opportunity to systematically approach the markets and individual risk parameters differently than being long-only.”

The Long and the Short of a Newly Popular Investing Strategy

A long-short money manager has the ability to both buy and sell stocks to help reduce risk during such less-than-optimal investment environments as a trendless market or even a bear market.

The long-short strategy often serves as a hedge from overly bearish markets by allowing investors to take advantage of upside potential (long positions), while also benefiting from downward movements of certain investments (short positions). In choppy markets – like those of today – the strategy can help investors book some gains as they focus more on capital preservation, and not simply appreciation.

In reality, investors should consider incorporating some form of a long-short approach as part of the overall asset allocation of their portfolios, experts say.

Brian Lipton, founder of Gaithersburg, Md.-based YellowWood Financial Advisors Inc., seeks out investments that are not correlated with traditional stocks and bonds. Lipton views long-short investment products as another piece to the portfolio construction puzzle, and has incorporated hedged equity mutual funds as part of a tactical allocation – a way of reducing exposure to the risk of a long-only securities position.

“We realized long ago that we cannot ‘time’ the markets,” said Lipton. “We typically allocate about 20% to 30% of our equity portfolios in a tactical manner. Hedged equity represents a part of that allocation that helps satisfy certain risk elements and, of course, allocations that reduce long-only exposure in this environment have been beneficial. We have found that hedged mutual funds have been a very good choice during periods of intense volatility and could work well during other times as well.

Lipton’s firm uses one fund that goes long on favored positions, short on out-of-favor positions, and another fund that buys equities and hedges them with short positions on various indexes.

“While the latter fund is 100% hedged today, that percentage could change based on their views of the market environment,” Lipton said. “Security selection is still important.”

Hedging Plays: Make Macro Calls, Dodge Market Falls

At Palantir, Samuels looks for opportunities to hedge long positions, while also seeking profits on the short side. In managing his long-short fund, Samuels will make macro calls on the markets and the economy, micro calls on companies he believes to be either under- or overvalued, and also employs market-neutral arbitrage trades by pairing long and short positions in similar securities.

“Right now, we are short the dollar by owning the [PowerShares DB U.S. Dollar Bearish Fund (UDN)], an unlevered ETF that inversely mimics the movements of the U.S. currency,” said Samuels. “That position represents a macro call against the dollar and the ETF shot up dramatically when the Fed announced its intent to aggressively buy Treasuries to lower rates. Additionally, we believe this short trade provides nice cover as some domestic companies may struggle relative to their international counterparts.”

Samuels’ fund is also betting against U.S. Treasuries through short positions in an ETF that tracks long-term government securities.

“Historically, central banks have had mixed records of holding rates down, particularly when their currencies begin to fade,” Samuels said. “Shorting Treasuries provides an opportunity to make money on that macro call, while also serving as a hedge against certain long industrial and consumer-related domestic equities that may struggle in a rising interest rate environment.”

Dave Walker, YellowWood’s director of operations, points out that his firm has begun using a long-short commodities-based fund as a way of employing this non-traditional investment strategy.

“We have been allocating a portion of certain clients’ portfolios into long-only commodities funds for years, but gains and losses have recently come so fast and furious that we chose to move into a hedged product,” Walker said. “We realize we cannot time these markets on a daily basis by investing long or short. But based upon the trends in the global economy and surrounding specific categories of commodities, a hedged commodities fund allows us to participate in this alternative asset with lower risk and volatility. We will trail indices when there is a quick rebound but, more importantly, we expect to curb the downside.”

Market Neutral Pairs

Palantir’s Samuels explains the pairs trading concept through a hypothetical example.

“The market-neutral pair trades entail buying a company in a high-quality security as measured by free cash flow (FCF), low debt, and [solid] profitability, and simultaneously selling a security in the same sector that we perceive to be [of a] lower quality based on these same parameters,” Samuels said. “Let’s say, we liked Intel (INTC) because of where the company is in its product cycle, its low debt position, and its positive cash flow. Conversely, we recognized that [Advanced Micro Devices (AMD)] maintains considerable debt and its last product introduction was under whelming. In this example, we may choose to go long Intel and short AMD.”

Samuels then discusses an environment that has the overall equity market declining by 30%, with Intel and AMD dropping 25% and 35% respectively.

“A properly executed paired trade would have returned 10% to the investor, even as the stock market as a whole lost 30%,” said Samuels. “The long-short manager then has the opportunity to unwind the arbitrage, but only one side at a time, if desired. We may believe AMD is more fairly valued after a drop of 35% and choose to cover our short, while still owning Intel, a high-quality stock that could appreciate should the market rebound. The long-short approach provides us significant flexibility, while the long-only manager has to identify high-quality stocks and then hope that the overall market direction cooperates.”

Client Interaction

YellowWood’s Lipton had not seen sheer panic from his clients – at least not before the Dow Jones Industrial Average recently fell below the 7,000 level.

“For the most part, our clients understand their allocations and we received very few distress calls,” said Lipton. “Nevertheless, we know the concern is there. When the Dow broke below 7,000, some became worried about further significant slides without any apparent market support. We spoke with them more about increasing the hedged positions and they were happy to control the downside better, while giving up a bit of appreciation potential. They were very interested in such investments, particularly given the uncertain environment we are in.”

And these days, a little peace of mind can go a long way.

[Editor's Note: Ron Brounes, CPA, is a regular contributor to Money Morning. A technical financial writer, Brounes, is president of Brounes & Associates, a Houston, Tex.-based consulting firm that provides writing, communications, and educational services for financial services professionals. Back in March, Brounes wrote about how the Obama stimulus package would affect your income taxes.]

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Source: How Long-Short Investing Can Lead to Profits in Today’s Uncertain Markets

[This is the eighth installment of a new series that looks at ways for investors to recover from the U.S. financial crisis. To check out the archive of previous stories in the series, just click here.]

For instance, a 5% to 6% contraction in first quarter gross domestic product (GDP) will look decent vs. the wrenching 6.3% decline the U.S. economy experienced in the fourth quarter. Mix in some still weak – but improving – corporate earnings season and there may be reason to hope that U.S. President Barack Obama’s prediction of an economic rebound in 2010 may not be off target after all.

Eddie Cohen, a market historian who is chief investment officer for Stavis & Cohen Financial, a Houston-Texas financial-management firm, points out that the U.S. stock market has endured three protracted bear markets since 1900 (1906-1921, 1929-1942 and 1966-1982) and sees evidence that the United States may be ensconced on one of those periods again.

While Cohen sees some positive indicators, he continues to advise that caution (or even cautious optimism) be the order of the day.

“Plenty of questions still need to be answered before we can proclaim an end to the bearishness and a definitive market recovery,” Cohen said. “At least, we have started to see some rays of sunshine on the horizon, and that is encouraging.  Still, this environment is not the time to be a hero.”

But there are three significant wildcards at play here that could keep the market from sinking into an even deeper malaise – and that could, in fact, be a catalyst for higher stock prices and perhaps even an improved economy in the months to come. Those three wildcards include:

• There’s an estimated $4 trillion in cash in investors’ hands on the sidelines – capital that could be drawn in to further pump up the markets, should the recent rally continue.
• The federal government has already committed to funding $11.6 trillion in stimulus initiatives, and the sheer magnitude of that government intervention could play a substantial role in determining just how long this downturn lasts – or how quickly it ends.
• Stocks are, in many cases, currently trading at levels not seen since the late 1990s, meaning the market is dangling bargains too enticing to ignore.

Cohen believes that investors need to remain cautious and to understand that market sentiment can literally turn on a dime, especially if the volatility levels remain high [there's some evidence that volatility has diminished somewhat in the past week, and is currently below what is usually expected for the start of the corporate earnings cycle]. However, the Texas investment advisor also foresees some potentially positive developments on the horizon and believes that patient long-term investors who are willing to ride out the short-term volatility may want to commit some money to stocks in profit from these low valuations.

Given that there is “an estimated $4 trillion in cash on the sidelines right now … as investors become more confident, some of these funds could potentially find their way into equities and help drive the markets higher,” Cohen said.

The Quarter That Was

When 2008 came to a close, investors hoped the nightmare had ended and some normalcy would return to the economy and the markets. It was not to be. During the first three months of the New Year, a $787 billion stimulus package, multiple blueprints for rescuing the nation’s banking system and a honeymoon period for a new presidential administration that was one of the shortest in U.S. history made it very clear that the nation’s economic nightmare was continuing.

Much of the data portrayed an economy in decline despite the promises by U.S. Federal Reserve Chairman Ben S. Bernanke’s that better times were coming. The U.S. Commerce Department initially reported that fourth-quarter GDP was down 3.8%, its worst showing in 27 years, though not as bad as many economists had projected. A few months later, however, Commerce Department analysts revised that statistic downward to 6.3% and confirmed that the recession had worsened.

Jobless statistics became the barometer for the nation’s declining economic health, as company after company announced major cutbacks. On Jan. 26 – in a single day so bad that it was labeled as “Black Monday” – about 75,000 jobs were eliminated ad the likes of Caterpillar Inc. (CAT), Sprint Nextel Corp. (S), Home Depot Inc. (HD), Texas Instruments Inc. (TXN), General Motors and others announced major job cuts. Even before that dark Monday, there had already been 170,000 job cuts announced that month – and that’s after a 2008 that saw the recession claim 2.6 million jobs.

“Some of the worst job losses are ahead of us, not behind us,” Wells Fargo & Co. (WFC) senior economist Scott Anderson told USA Today at the time.

One-time global giant Citigroup Inc. (C) fell briefly into penny stock territory and came within a heartbeat of nationalization as the U.S. government finally opted to inject more money into the former financial-sector stalwart. A late-quarter restructuring plan seemed to better position Citi.

Nor did the trouble stop with the banks. Two of the U.S. Big Three automakers – General Motors Corp. (GM) and Chrysler LLC – moved closer to bankruptcy as the government rejected the American carmakers’ plans for reorganizing. Indeed, the Obama administration even “suggested” GM’s CEO pursue other endeavors, and laid down serious guidelines regarding future intervention. Even so, bankruptcy may be unavoidable.

But then a funny thing happened on the way to Great Depression II. Citi, Bank of America Corp. (BAC) and JPMorgan Chase & Co. (JPM) each announced promising results for the first two months of the year, surprising investors and igniting a late-quarter stock market rally. In an interesting parallel development, a “surprise” announcement by Wells Fargo & Co. (WFC) last week added fuel to that already-existing rally in financial-sector stocks, and in the market in general.

Some confidence returned to the boardroom – at least within the healthcare sector – as major deals involving Merck & Co. Inc. (MRK) and Schering-Plough Corp. (SGP) ($41.1 billion) and Roche Holding AG (ADR: RHHBY) and Genentech Inc. (DNA) ($46.8 billion) moved forward.

Electronics retailing giant Best Buy Co. Inc. (BBY) reported better-than-expected profits as consumer activity suddenly picked up (at least, above the dismal levels of the fourth quarter). The credit markets began to thaw a bit as corporations issued new debt and the U.S. Federal Reserve offered up a plan to buy U.S. Treasuries as a way of keeping interest rates low.

Though the Dow Jones Industrial Average declined 13.3% for the quarter, March was its best-performing month since October 2002. The tech-heavy Nasdaq Composite Index declined 3.07%, but enjoyed a March that was actually its best month ever. The Standard & Poor’s 500 Index declined 11.67%.

Some of the late-quarter economic reports seem to reflect this brighter outlook. In manufacturing, for instance, factories continued to struggle as industrial production fell to the lowest level in almost seven years, though a favorable durable goods report offered some optimism as the first quarter came to a close.

Home sales likewise offered some cause for optimism, rising in February as buyers took advantage of low rates and a tax-break for first-time homeowners. Retail sales statistics were a bit better than expected – especially after removing dismal auto sales from the mix. And inflation – a much-feared foe with the level of government spending that’s taking place – remained well under control, even as talk of deflation also seemed to subside.

Stocks continued their strong run, even after the quarter closed. Since then, in fact, the Dow has rallied 6%, the S&P 8% and the Nasdaq 8%.

Sound Strategies to Follow No Matter Which Way the Market Moves

Nat Levy, a principal with Houston-based McNeil, Levy & Friedman LP, is a five-decade veteran of the financial-services sector, and has seen his share of uncertainty. In the near term, it rarely pays to prognosticate – so he doesn’t.

“I am unable to predict short-term market or economic movements and don’t know of anyone who can do more than guess at this,” Levy says.

Even so, at a time when many investors are talking about “new rules,” or “new realities,” Levy says it pays to stay the course.

The one prediction he will offer is that some investors will look back on miscues they made today with more than a little regret.

“Right now, we find ourselves in one of those “if only I had…’ periods,” said Levy.  “My one educated guess is that in five years from now we’ll look back and think “If only I had invested in this; if only I had remained invested in that, etc.’.”

Stavis & Cohen Financial’s Cohen points to the usual suspects like automakers and banks as industries that continue to face considerable challenges in the periods ahead.  While he sees signs of renewed housing activity in terms of new and existing home sales, he acknowledges that prices continue to fall each month, foreclosures are increasing, and the newly laid-off workers could exacerbate those trends.

Cohen – like Money Morning – believes that commercial real estate may be the next shoe to drop; vacancies are increasing, rents are under pressure, and banks may not be willing to loan large sums of money to related companies looking to refinance.

Because inflation could become a problem, Cohen says investors should have some exposure to gold in today’s environment.

“The unprecedented level of government intervention has added significant liquidity to the marketplace, but, ultimately may lead to higher levels of inflation,” he said. “Gold can serve as a potential hedge against such price pressures.  Additionally, as the country’s debt and deficit positions mount, the dollar could remain under pressure and gold can be viewed as an insurance policy against a weak currency and the uncertain times faced today and in the future.”

Cohen states that investors can invest in gold directly by purchasing bullion or through funds or exchange-traded funds – one being the SPDR Gold Shares exchange-traded fund, or ETF, (GLD) that track the price movements of the so-called “yellow metal.” His firm uses a manager who buys bullions and stores it in a vault, which he says gives his firm’s clients the opportunity to access a product whose price moves more in lockstep with the market price of gold, and is even more cost effective than gold funds or ETFs.

In terms of stocks, Cohen believes investors should consider small-cap shares.

“Historically, coming out of recessionary times, small-caps are among the best performing equity asset classes,” he says. “Granted, many of these companies may have struggled during the dire economic times as investors shun anything other than industry leaders. Now may represent a decent time for cautiously optimistic investors to again look at small-cap companies, particularly when combined with some exposure to gold as a hedge against renewed downside pressures on stocks.”

Cohen recognizes that the newly enacted government programs could prove helpful in jump-starting the U.S. economy – which should enable the recent upward move in stock prices to continue. In particular, he sees some successes in the Fed’s attempts to get corporations and municipalities borrowing again.

“The credit markets definitely are showing signs of life,” said Cohen. “In the first quarter, domestic companies issued over $350 billion in new investment-grade paper and interest rate spreads between [corporate bonds] and Treasuries are coming down. Likewise, according to Lipper, investment-grade [municipal bonds] were up 4% to 5% in the first quarter and investor demand for such offerings seems to be on the rise. In fact, the state of California moved up a recent sale of $4 billion in bonds by a day to accommodate the demand for what turned out to be one of the largest tax-exempt offerings since 2007.”

Mortgage-market distress could also create some investment opportunities for investors who do their homework, Cohen says.

“I am a firm believer that challenges create opportunities, and no products have experienced more significant challenges over the past few years than mortgage-related securities,” said Cohen. “Amid the subprime debacle and related credit crisis, all mortgage products have struggled and even the higher-quality paper is being priced as if it is a toxic asset. We use a fixed-income manager who has been buying up more stable mortgage-backed issues at what he perceives to be tremendous values because of the negativity that has enveloped the entire asset class.”

A market historian to the end, Cohen likes to return to what he knows best when attempting to analyze just where he believes the markets will head next.

“Dating back to 2000 through mid-March, the equity market lost about 3% in value, so history may suggest we are about halfway through what some would call a secular bear market,” Cohen said. “During such times, it is quite common to experience periods when markets really take off. In fact, during the last few weeks in March, equities rose over 20% and some investors have pointed to that move as evidence that the market had bottomed and the turnaround had begun. In reality, since October 2007, we have seen six rallies of various magnitudes.”

Source: After a Tough First Quarter, Investors Have Cause For Cautious Optimism

[Editor's Note: This look at the U.S. economy and stock market is the latest installment in a series of Money Morning quarterly reports that will examine such topics as gold, housing and oil. These reports will now be a regular feature at the end of each quarter.]

Here he shows us covered call strategy investing and how it works.

This from Karim:

Just what is the best way to profit in a stock market like this?

Our mission here is not only to show you the sectors, industries, and stocks that are set up to fare well, and the trends you can play to your advantage, but to also show you how to profit from them in more advanced, sophisticated ways than ordinary investors.

And when I say “advanced” and “sophisticated,” I don’t mean “complex to understand” and “difficult to execute.” Far from it.

In recent columns, we’ve talked about investing in water, gold investments, the real estate market, and much more (check out our Smart Profits Report archives if you’ve missed anything).

The bottom line is that amid all the bailout and stimulus talk… the volatility… the fear… the constant doom and gloom… we continue to stress that there are ways to negotiate brutal bear markets – ways that can still bring in strong profits.

Covered call investing is one of them…

Covered Calls: The Perfect “Cover” For An Imperfect Market

We realize that times are tough. No doubt about that. But we’re not sitting around complaining about it. Our focus, as always, is purely on showing any investor how to take profits from any market.

And we’ve demonstrated that in recent weeks, due in no small part to our covered call strategy.

Now, before I go any further… I understand that options strategies can sometimes spook investors. They seem complicated, especially since most people are used to just buying and selling stocks.

But our job is to educate you… helping you become a smarter investor, able to take bigger profits…

2 Key Elements That Will Help You Beat Wall Street…

In some ways, Wall Street is like the world’s biggest casino.

The devious types who make their living there don’t want you to know about the tips and techniques that can help you win.

They’re perfectly happy for you to remain in the dark, unwilling to teach you about hedging your bets. They just want you to make them and grab your money.

Now, in some cases, I’ll be the first person to admit that hedging your bets is a flat-out bad idea. However, this is not one of those cases. And I’ll tell you why…

This type of market, complete with its daily volatility and blow-ups, requires that you expand your investing acumen. And this is where we come in, giving you the two key elements you need…

1. The necessary know-how.
2. The specific trades to take end-game profits.

Covered Call Buyers vs. Covered Call Sellers… Who Wins?

Using options does not mean gambling. If you’re relatively new to the options world, that’s the first fallacy you need to put aside. Options actually work very logically. With every buyer, there’s a seller.

The Buyers: 9 times out of 10 – especially with short-term options trading – buyers lose out. And with good reason: It’s like trying to predict where a stock will go in a couple of weeks or months – something that nobody is entirely capable of doing.

The Sellers: Options sellers, on the other hand, usually make money because they’re basically betting on this lack of supreme knowledge. Huh… how does that work? Simple…

While they acknowledge that they can’t predict where an index or stock will go with pinpoint accuracy, they at least want to try by making a well-informed, educated estimate. And they want to get paid for trying and waiting around. In particular, with deep-in-the-money covered call selling or put-selling, they want to own the underlying shares, but at a price that they specify.

I’ll give you an example…

Using Covered Calls To Invest In Gold

As we’ve written about here before, we liked gold investments when no one else did. So we put our money where our mouth was and bought shares in Goldcorp (NYSE: GG), a major gold producer.

But we were also aware that gold prices would likely remain volatile for a time, keeping shares from reaching our targets right away.

So what to do?

Easy. We bought the shares and sold call options against our position. This not only reduced our cost, but also gave us a quasi-dividend and increased our chances of a win.

In the end, our shares didn’t get called away from us at options expiration. But that was fine with us. We got another opportunity to lower our cost and increase our potential for a win by selling more calls.

We did the same with a recent trade in the Xcelerated Profits Report – and I’ll be doing it again very shortly. In this market, it’s how you play the game that counts. It’s all about risk management.

The Covered Call Investment Strategy – A Gateway To Safer Profits

In case you don’t know, we have the resources for you to learn about the covered call investment strategy (and several others, for that matter) in more detail on our Smart Profits Report website.

Scan our archives. It’s all free and essential reading if you’re serious about investing. We provide step-by-step instructions on how to execute various trades, as well as the rationale behind them.

And if you find something you really like, why not take your investing to the next level?

Source: Kiss Goodbye To “Ordinary” Investing: Why Smart Investors Use Covered Calls

At this point, the temptation to work as long as possible, and then blow what remains of your savings on a round-the-world cruise and a suicide pill is considerable.

However, such despair is unwarranted.

Unless you have already given up all paid employment, or absolutely have to retire in the next year or two, the current bear market may have made your eventual retirement prospects more secure, not less.

You see, the most damaging factor for your retirement happiness was not the current downturn, but the preceding decade-long bubble.

Let me explain.

Savers who devote an equal amount each month to their long-term plans benefit from an important mathematical principle: Dollar cost averaging. Under dollar cost averaging, you put in the same amount of money each month, so that amount buys more shares if prices are low than it does if prices are high.

Thus, if a mutual fund trades at $1 in month one, $2 in month two and $1.50 in month three, then a dollar-cost-averaging investor investing $300 per month will buy 300 shares in month one, 150 in month two and 200 in month three. After his month three investment, he will own 650 shares at a cost of $900, for an average cost of $1.3846. Since the average price of the shares over the three months was month three’s $1.50, he has made an extra $0.1154 per share compared with the average share price.

That’s why prolonged bull markets are so bad for retirement investors (unless they are lucky enough to retire before the bubble bursts). In this case, the Standard and Poor’s 500 Index stood at 459.27 at the end of 1994. Then after February 1995, when U.S. Federal Reserve Chairman Alan Greenspan moved to an ever-easing monetary policy with low interest rates, it took off for the stratosphere.  It passed its current level of 825 in early 1996, and except for a short period in 2002 has traded above that level ever since.

So, even though retirement savers from 1996-2008 thought most of the time that they were doing very well, in reality they were buying shares at an over-inflated price, and just about every one of their monthly contributions is currently showing a loss.

It’s not the current bear market that has caused that loss. Stock prices in 1996-2008 were always at excessive prices, so a major correction was bound to happen sometime. If the correction had happened in December 1996, when Greenspan made his famous “irrational exuberance” speech, the market would have on average been substantially lower over the subsequent 12 years. And a retirement investor who had saved over that period would be substantially richer today because he would have owned significantly more shares of the mutual fund in which he had invested.

The wise retirement savers who have a few years to go should hope the current lower stock prices stick around, maybe even go lower still provided they recover before they has to draw on the savings or convert them into an annuity. By continuing to invest regularly at these lower prices, the return from dividends and capital appreciation will compound more quickly, particularly if they buy stocks that have a substantial dividend yield.

Even if their savings remain adequate, they shouldn’t convert them into an annuity because annuity rates are currently very low. With long-term Treasury bonds yielding less than 3%, actuaries factor that exceptionally low return into their annuity calculations.

Right now, a 65-year-old man who buys an annuity can expect to receive only around $74 per $1,000 of investment, without any protection for inflation or guaranteed minimum return if he dies quickly. Once interest rates rise, as they are almost bound to, that annuity rate will rise in step with them.

Rather than convert into an annuity, the retirement saver should simply invest in stocks that are both solid and yield more than 7.4% – and there are still plenty of them out there. That way, he can achieve the same return as an annuity while preserving, and maybe even increasing, his principal – in addition of course to any further monthly payments he can make while still working.

By building a portfolio of such stocks including a selection from emerging markets, he can take advantages of the higher-dividend payouts frequently found outside the United States.

Finding stocks with dividend yields equal to or greater than an annuity yield was tough when the S&P 500 was at 1400. But at 800, it’s a lot easier, even if you want to avoid the financial sector for obvious prudential reasons.

Such solid companies as General Electric Co. (GE), BP PLC (ADR: BP), Du Pont (DD), Newell Rubbermaid Inc. (NWL) and Limited Brands Inc. (LTD) yield well over 7% currently, and that’s without venturing into emerging markets companies.

If your retirement portfolio has been decimated, don’t despair. At these lower stock prices it will be much easier to build its value up again, and because stock yields are higher you won’t need so much capital to generate the income you want to live well.

Source: Retirement Investing: How Bear Markets Can Help Your Retirement Planning

That got me wondering if there was any correlation between the beginning and end of historical bull and bear markets.

A quick search on the internet turned up a chart that showed bull and bear markets since 1942. Since the chart was created last September, it is a bit out of date, but the historical data serves our purpose.

Utilizing this data, I was hoping to find that the recent market bottom would be 393 days after July 19, 2007. Unfortunately, that’s not the case. That would have put the bottom of this bear market on August 16th, when in fact the recent low (and by some estimates the end of the bear market) was three months later on November 20th.

Then I took another look at the chart. As I mentioned, this chart was originally published on September 6, 2007. Looking at that date on the S&P chart, there is a higher close than July 19. The S&P actually hit a high on October 9, 2007 at 1565.15 before it began the current slide.

Therefore, I re-ran the numbers using October 9 as the end of the bull market. Guess what day is 393 days later? No, it’s not November 21, that would be too perfect.

However, November 21, 2008 is 408 days after the ‘revised’ end of the bull market, so only 14 days more than the average.

What does this all mean?

Well, if you are like Rick Pendergraft and me, the eerie coincidences lead you to believe that November 21, was the end of the bear market, and we are now in the beginning stages of the next bull market.

It also allows you to make strange predictions, like this one:

This bull market will last until May 11, 2013 when the S&P hits 1878.46

Source: Why The Number 393 Is So Important

More from Justice in Taipan Daily:

Hear ye, hear ye, one and all: The supercycle is dead. Long live the supercycle!

Commodities on the whole have declined nearly 50% from their peak as a result of the credit crisis. This has led some to declare that the “commodity supercycle” – the idea that we are merely in mid-innings of a massive, multi-decade commodity bull market – is defunct too.

I’ll admit it… the weekly chart is hard to ignore. If one had to assess the health of the supercycle by way of the Reuters CRB Index alone (as shown above), Monty Python’s Dead Parrot sketch would spring to mind.

Really though – in spite of deeply dire appearances, it’s a fair question to ask: Has the commodity supercycle shuffled off its mortal coil? Are we now dealing with an “ex-supercycle?”

Believe it or not, there’s a case to be made that the commodity supercycle is not dead – that it really is just resting – despite the speed and ferocity with which commodity prices have been chain-sawed in half.

Let me explain…

How You Can Survive… And Thrive, During The Most Savage Financial Shock of This Century

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Cures What Ails Ya

There is a hoary old saying in the commodities biz: “The best cure for high prices is high prices.”

What this means is that, when a commodity gets pricey enough, production naturally expands. Expensive oil & gas leads to more drilling in hard-to-get-at places… expensive hogs lead to more hog farming… expensive corn to more corn acreage being planted, and so on. High prices, in other words, act as a “cure” for high prices by drawing new supply into the market.

The same idea works in reverse: “The best cure for low prices is low prices.”

As you can probably guess, the “low price” cure means that when a commodity gets cheap enough, producers start throwing in the towel. New projects are canceled… existing production is cut back… and marginal production is shut down entirely. As profit margins fall, more and more producers rein it in… or simply throw up their hands and quit. Over time, this winnowing process shrinks supply until it matches up with newly reduced demand. Then things stabilize, demand shifts, and the cycle begins anew.

So here’s the ironic thing: Those who declared commodities to be in a “bubble” feel vindicated because commodity prices have been smashed. And yet, today’s ultra-low commodity prices are merely reestablishing the same conditions that fed the supercycle thesis in the first place!

From High to Low (in Record Time)

When the commodity bull really hit stride, it was largely based on a strong outlook for global growth. With so many emerging market countries coming of age, resource after resource was projected to be in short supply as far as the eye could see. Investors of all stripes and sizes, from institutional on down, wanted a piece of the action.

Then the mortgage bubble popped, trust and liquidity evaporated, and credit and commerce fell off a cliff.

Not wanting to be left out, commodity prices jumped off a cliff too… and now things have come full circle. Commodities fell so violently and so quickly, we’ve been rudely transported backwards (or perhaps forwards) to the “low prices cure low prices” part of the cycle again!

For many commodity producers – and metal miners in particular – these new low prices (no pun intended) aren’t high enough to justify keeping the doors open. (That hushed sound you hear? It’s an idle haulpak with an empty gas tank; keys left dangling in the ignition.)

Pity the Miners

Pity the poor miners. Well before the panic and ensuing collapse, profits in the mining business were being squeezed by rising costs. The cost of essentials like fuel, skilled labor, equipment, and even oversized truck tires threatened to spiral out of control.

Due to this relentless “cost creep,” many of the miners – precious metals in particular – struggled to maintain healthy margins even when metals prices were riding high.

And thus when the credit bubble burst, the fall in prices was so vicious that many miners’ profits were simply wiped out. All those sky-high operational costs came down too, it’s true – but that was cold comfort in light of bank credit, investor capital, and pricing power all disappearing into thin air at once.

So now we have a situation where marginal miners all over the globe are shutting down. Operations that were profitable three to four months ago are now bleeding red ink… and screeching to an utter halt.

“Virtually all [mining] projects except those of the biggest companies need financing,” the Wall Street Journal observes, “and even some of the largest still need to borrow after starting out with equity capital.” The debt window is closed, and raising new equity in these conditions would take a miracle.

As a result of all this, production levels are being scaled back rapidly. New production is no longer in the pipeline. And post-panic prices suggest the world has given up on growth.

The Global Growth Question

Say, what about global growth? Is the uptrend in long-term demand dead too?

We know that a large element of this “fire sale” was forced asset selling… a vicious little quirk of the credit crisis that has nothing to do with fundamental outlook. But investors also seem to be arguing for a world of much diminished demand for a long time to come. That could be a mistake.

Rick Rule, a legendary natural resource investor with 35 years experience, points out that emerging market demand going forward could be “steadier… than many people think… simply because the developing countries’ balance sheets are better than we are accustomed to.”

I agree with Mr. Rule. This is the first crisis we have seen where the balance sheets of many emerging countries actually look better than those in the Western World. Not all, but many, of the upcoming emerging market players stuffed the proverbial mattress with cash during the run-up.

China alone, for example, has nearly two trillion dollars in reserves… Russia more than half a trillion at last count… India nearly a quarter trillion. Having that kind of cash on hand can smooth over a lot of bumps on the road to middle-classdom. Their stock markets may be punk, but emerging market consumers could be back in action sooner than we think.

Lags and Gaps

There is another thing to remember about commodity price swings: Normally the shift from high to low prices (or vice versa) takes quite a while. This is because of time lag. Simply put, it physically takes a long time for production to adjust to an upward shift in demand. It’s not as if you can throw a switch and suddenly have a new mine or refinery or power plant in operation just like that. The preparation process – assessing, planning, funding, building – takes years.

Much of the supercycle thesis was predicated on the idea that it will take a very long time – perhaps a decade or two – for the world’s lagging commodity infrastructure to catch up with soaring global demand. As far as I’m concerned, that thesis is still in play.

Right now, commodity production trends and global demand trends have both flat lined (or even flat out declined). But when commodity demand trends start ticking up again – something that is bound to occur – it will happen at a faster rate than production can match. In the long term, this velocity discrepancy is what truly matters.

Think of two upward sloping lines that intersect in the lower left corner a graph. The X axis equals time, the lower sloping line equals commodity production, and the higher sloping line equals global demand trends. Though both lines move higher with time, the distance between the upper and lower line only gets wider as you move to the right.

That’s why I think the supercycle still lives, be it lying at the bottom of the stairs in a heap at moment. Global demand will be back… and when demand trends get back on form, they will again outpace our ability to keep up. And with so many commodity operations scaled back or mothballed thanks to the credit crunch, the starting gap will be even wider when things get rolling again.

And Don’t Forget Gold

And by the way, don’t forget gold in all this. With fiat currencies headed for a predestined tragedy of Shakespearian proportions, it doesn’t take a genius to see how physical gold demand could rise. Gold bars and coins are already flying from the vaults. Faith in the yellow metal will only wax further as faith in paper wanes.

And as for the miners’ role? John Embry, Chief Investment Strategist for Sprott Asset Management, states things flatly: “When the gold’s all gone, the market will go nuts.”

“If gold hasn’t moved up by the end of this year, I would be very surprised,” Embry says. “People don’t realize how distressed the gold mining industry is. Even at $1,000, miners weren’t doing very well. At $800, the entire industry is in crisis. Costs have risen so much, nobody’s making any real money. In fact, some mines are starting to close.”

Embry thinks gold would have to hit at least $1,200 an ounce before the shuttered mines reopen… a 50% rise from gold’s price as of this writing. And if, or should I say when, gold reaches that new high, it will likely be on the way to even higher climes.

And now if you’ll excuse me, I’ve got to go research some very attractive junior mining candidates. Long live the supercycle!

Source: Is the Commodity Supercycle Dead… or Is It Just Resting?

– The broader Standard & Poor’s 500 index did even worse. The S&P 500 was the worst performer among the major indexes. It shed a whopping 6.1% and hit its lowest level since April 2003. The fear and loathing on the Street is palpable.

– Today, U.S. stock futures slipped thanks to what normally chirpy MarketWatch calls “the brutal economy that companies are navigating.” S&P 500 futures edged 2 points lower to 900.80 and Nasdaq 100 futures fell 7.25 points to 1,240.70. Dow industrial futures rose 5 points.

– Agora Financial’s Chris Mayer, one of the smartest contrarian investors we know, is quoted on Addison Wiggan’s 5 Min. Forecast blog as saying: “What we are going through now is a history-making crash. There is a reason it caught so many people by surprise — it hasn’t happened before, not quite in this way.”

– Addison also quotes Bill Bonner. Bill has been calling this crash for years in The Daily Reckoning. His “trade of the decade” — sells stocks, buy gold outlook — now looks like a very wise move. Bill says we about to be hit with a protracted bear market combined and a deep recession.

“When Mr. Market goes into a sulk, he takes a long time to come out of it. Real bear markets last 10… 15… 20 years. Judging by the meltdown in the financial sector and the rapid losses we’ve seen over the last three weeks… we have a real bear market on our hands…

“With no more easy credit available to them, consumers are doing what they have to do — they’re cutting back. How much? For how long? No one knows the answers to those questions, but our guess is this: more and longer than you thought.”

– We didn’t expect permabear Nouriel Roubini to be calling a bottom. But we didn’t expect such a bleak prognosis either. Roubini spoke yesterday morning on CNBC. Henry Blodget on Clusterstock summarizes Roubini’s breakdown of the coming financial Armageddon:

# The worst is yet to come.
# The next few weeks and months are going to have lots of negative surprises on the economy
# The flow of market news is going to be much worse than expected–just like last week when every piece of news was awful
# Earnings are going to surprise on the downside. There’s going to be a sharp fall in earnings, not just financial sector, but everywhere.
# Even in financial system, where we avoided a systemic global financial meltdown by an epsilon, there will be significant risk downward. Emerging markets going into a crisis. Having a blow up of the CDS market. Having hundreds of hedge funds closing down.
# So I significant downside risk for the financial markets and economy. I think the worst is yet to come.

– Blodget says yesterday’s wipeout in the stock market was a good thing, because it means the market is behaving rationally.

Trading down on profit warnings is a pretty rational and even normal response to economic news. The reason that’s good news is that it means we’re not just experiencing mysterious problems in credit markets or some new financial innovation no one ever heard of exploding all over the markets.

– Argentina, where the ContrarianProfits offices are based, is royally screwed by the looks of things. The hugely unpopular president President Cristina Fernandez de Kirchner has announced she will seize pension funds. Cristina, ever the populist, claims the move is to “protect” people’s money. The reality is she plans to use the funds’ $29 billion to meet the country’s spiraling financing needs. The Argentine stock exchange, the Merval, plunged as much as 18% on the news.

– Addison Wiggan’s take on it in The 5 is dead on.

Beset with debt and overcome by its bond obligations, the Argentine government nationalized $30 billion in private pension funds yesterday.

Fifty-five percent of those pensions are government debt holdings… and now that Argentine leaders have seized them, they can essentially write them off. The rest of the holdings they’ll use to finance debt payments and keep the government running.

Argentina is the second largest economy in South America. It is one of the world’s top five exporters of beef, soy, corn and wheat. It still can’t afford to keep the lights on. Argentine citizens are being asked to suspend reality and trust the government is good for the money when they’re ready to retire.

Hmmmn… puts us in mind of that ’70s-era Rainbow rock ‘n’ roll tune “Can’t happen here, can’t happen here. All that you fear, they’re telling you, can’t happen here.”

In classic contrarian style, some Wall Street pros are happy the bear is back.

No, they aren’t sadistic. It’s just that in the majority of bear markets going back to the 1950s, stocks, on average, rose soundly during the six and 12 months after the markets were first labeled as bears. That was particularly the case when the major gauges slipped more than 20% off their cyclical highs – the technical definition of a bear market.

As of Monday, all three major gauges are in or just above bear market territory, with the Nasdaq already having spent some time in the bear zone during the March lows, before recovering. And a bigger recovery could be in the works now.

If you listen to mainstream media sources like CNN you’d think that the bear market is over before it even began.

By contrast Bill Bonner sees more trouble ahead when consumer spending actually goes down,

Stock markets all over the world are getting whacked. They’re at a 5-month low, even beneath where they were when Bear Stearns went bust. Japanese, European and American stocks (as measured by the S&P) are all in bear market territory – all down at least 20% from their peaks.

Naturally, “some investors are beginning to scent a possible end to the slide.”

It was dumb money that was buying stocks at their all-time peaks. Not only in the United States, but everywhere. It is imbecilic money that buys now, in our opinion.

We are a long way from “capitulation territory.” When it comes, you will not see stocks selling at 15 times earnings. You’ll see them selling at 5 times earnings. And you won’t see the Dow at 14 times the price of gold. You’ll see it at 2, 3 or maybe 5 times the gold price.

Most importantly, when investors finally give up on stocks, you won’t find articles in the major press telling you that investors are “on alert” for the bottom. They will have lost interest – and their money – long before.

Despite all their woes, Americans have still barely begun to cut back on spending and begun to save in a major way. Sooner or later they will. And if the savings rate goes back to where it was in the early ’90s – at nearly 8% of personal income – it will take about $800 billion out of consumer spending. You can imagine what that will do to retailers…to the auto and aviation industries…and to Wall Street.

Stay clear of stocks, dear reader. Stick with cash and gold.

Steve Sjuggerud is no cheerleader but he has a less gloomy look at the bear. He says,

Commodities are up by triple digits since the end of 1999, and stocks are down in that time. The scary thought is… if the pattern holds, we could see stocks underperform until as late as 2016.

In my newsletter True Wealth, we wait for opportunity… We buy things that are cheap, hated, and in the start of an uptrend.

I don’t think we’ll have to wait until 2016… but we haven’t seen the uptrends yet. It’s an understatement to say it’s an ugly market out there. We’re simply doing our best to avoid catching falling knives.

It’s best to wait for the falling knife to hit the ground and come to a stop before carefully picking it up. By waiting for the uptrend, we might miss the first 20%-25% of a move… but it’s completely the right way to go now. We can’t know where the bottom is.

Right now, I’m seeing more cheap and hated opportunities than I ever have in my career. That’s what I’m excited about. And that’s the positive thing about bear markets… They create value.

If you can’t bear to stay on the sidelines, Keith Fitz-Gerald offers these five tips for profiting in a bear market.

Now that we’re in the midst of a new bear market, here are the five secrets that will pave the way to bear-market profits:

1. Don’t Try to Catch a Falling Knife: The first bad news is never the last, as so many investors found out when the Internet bubble imploded in 2000, quickly eradicating $14 trillion of wealth. If the fundamentals don’t match up with the stock’s price, don’t buy.
2. Don’t Overpay: One of the biggest miscues bear-market investors make is in concluding that certain stocks are a bargain simply because they’ve traded down to historic lows. It’s better to consider “tangible book value.” The reason: Tangible book value represents what a shareholder can actually expect to receive if a company turns turtle; it’s a good measure of what the firm’s real assets are worth. So, at a time when earnings are decelerating – or have vanished completely – buying companies that are trading below tangible book value can provide an extra measure of downside protection, especially when you’re talking about a company that’s perfectly positioned to capitalize on powerful global trends.
3. Look For Pricing Power: When the going gets tough, the tough… stop buying. At least, they stop buying the stuff they want, and shift, instead, to the stuff they need. This has a major ripple effect in the economy. Many businesses are forced to go on the offensive to keep the customers they have, or to “win” new ones – at a time when consumers are loathe to spend. This suggests that companies that are able to continue, or even ramp up, their advertising spending make the best bets. Especially alluring are companies that can keep their customers – and even raise prices – in the face of a bull market.
4. Watch for the “New Research Coverage Initiated” Signal: Although Wall Street hates to admit it, analyst ratings and recommendations aren’t intended for us individual investors. At least, that’s been the case historically. Investment banks actually use their company “coverage” to generate investment-banking deals and to cozy up to the senior executives of the firms that are being “analyzed.” Since analysts often have access to insiders long before they publish their “reports,” new coverage can signal positive future growth or expansion plans.
5. Drill for Dividends: Many investors focus on so-called “growth stocks” in their rush for riches, when study after study demonstrates that dividend-yielding stocks can offer as much as a 25-1 advantage. One study by Ned Davis Research is particularly telling, noting that dividend-paying stocks provided returns of more than 10% a year from 1972 to 2005. Non-dividend paying stocks, in contrast, posted gains of just 4.1%. Given that this research study started at the worst possible time in the past 40 years – just prior to the “bear market” of 1973-1974, which dragged on for 21 months and caused shares to lose 48.2% of their value – these numbers are especially noteworthy.

Follow this playbook, and you won’t have to remain a spectator during lousy markets. You’ll be out on the playing field – and you’ll beat the bear.