When is the best time to buy up on stocks again?

By Neville Bennett

Friday 30th August 2002

The world's sharemarkets have taken a battering this year. By July, the main indices had lost about 40%. While the Japanese, European and British markets remain depressed, the US market has rallied by 20% in the past five weeks.

For many chartists a rise of 20% is significant and the implication is that the bear market is over. Is it really over? Should investors climb into shares?

Before taking precipitate action, investors should carefully consider their own needs.

They might also wonder why markets have been so volatile.

New Zealand has been stable but the important S&P 500 index in the US fell from over 1500 to 800 recently.

The Nasdaq is a quarter of its high, a classic bubble, the result of manic optimism. Japan's Nikkei fell from 39,000 in 1989 to 9000 recently.

These indices seem to indicate a classic inverted "V" shape of bear markets.

It is important to be cautious about rallies. Even when indices are basically falling there are rallies.

After the great crash in 1929, there was a rally of 50%, but the Dow Jones proceeded to crash again to 41 in 1932.

It had been at 85 in 1923 before growing 450% in the jazz boom. It took 15 years after 1932 to recover.

Even if the 1929 episode is dismissed as exceptional, it is worth noting there have been two other 20% bear market rallies recently, where if investors had piled in they would have lost money. After a closing low in March 2001, the Dow put on 20% but then lost it. After the September 11 crisis, stocks recovered amazingly to regain their losses by November 19, but plateaued and went into a steep decline until July, 2002. Bull markets always end lower than when they started.

Investors may also consider the risk of further revelations of scandal and fraud. Enron went bankrupt after disguising its financial position. WorldCom's chief financial officer admitted he had fiddled the books.

Vivendi, a huge French media conglomerate has been driven to the brink of disaster by mere rumours of creative accounting. Even experts have been caught out by these dastardly deeds.

Many hedge funds that specialise in buying distressed debt have lost a fortune on WorldCom after its first confessions. As more news comes out they rue the day they believed the balance sheet.

There may be more losses as many companies and institutions are revising downward their projections of future economic growth.

The three biggest economies - the US, Japan, and Germany - are in recession, or near it. World trade will turn down later this year, affecting many businesses.

The bear case also includes an argument that the markets have not been severely tested in August. It is the northern hemisphere holiday season and not much happens.

There was a vacuum of significant data. But September is a different story, with important releases on employment, manufacturing, housing and confidence. Earnings might also disappoint.

Nevertheless, there is also a strong bull case.

The bulls insist a 20% market rise in August means the bottom has been reached and that there will be a sustainable rally. They argue the recent bear market is the longest since 1940 and that the rebound will be the greater for the length of the downturn.

They project a 40% rise as a certainty, although a minority think the rebound will be moderated by share valuations having a higher P/E ration valuation than in other bear markets.

So should an investor test the water temperature?

One gambit is to look at defensive stocks. Even if times get harder, and trade turns down, people will still need to eat, drink, smoke and consume electricity and oil, even if they postpone the Porsche, designer's clothes and dramatic holidays.

If the bear market resumes, however, even defensive stocks lose some valuation.

If the investor remains cautious in assessing present risks, the old adage "cash is king" remains valid. Investors should avoid putting all of their eggs in one basket and aim for diversification. As most of us are heavily into property, to add cash, fixed investments and bonds makes some sense.

Obviously, shares are useful but not to the exclusion of balance.

Cash has the merit that it retains value and preserves opportunities.

Gold might be tempting as it has rallied from $US260 an ounce to $US310 but shares have surged and seem fully priced.

Cash is safer.

There are some difficult times ahead, when the horizon is cloudy, when the strategic necessity is to preserve wealth, and not risk it on casino-like bids.

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