Volatility and Opportunity in a Bear Market

Opportunity in a Bear Market
The stock market's volatility sure does reflect a lot of uncertainty and fear out there. While there's good reason to be cautious, there's also good reason to start researching some possible buying opportunities. As the dominoes continue to fall, it can mean the strong companies that are still standing once the dust settles will be poised to eventually become even stronger with some of their competitors out of the picture. And the stock prices of many of those strong companies have suffered as much as the rest of the market, meaning that the stock of great companies can now be bought at a substantial discount.

Just as a raging bull market can boost even the stock of so-so companies into high-profit territory, an extended bear market can maul the stocks of solid companies with excellent long-term growth potential. But while investors as a group may have no problem buying over-valued stocks when the market is on an upswing, those same investors are often afraid to buy the same stock at a deep discount in a turbulent market.

If it was a good stock at $65 a share, it should be a great stock at $25 a share, as long as the company's fundamentals remain strong. But what if it goes down to $20? Well, there's a pretty good possibility that it could, but you also can't predict when it will turn around for the better. So rather than worrying about trying to get in at the rock-bottom price, do your research and decide on what you believe is a good price for ownership in a solid company. The short-term market fluctuations are likely to remain messy for some time, but the mess presents great opportunity for the investor who has their sights set on the long-range.

Market-timing is always difficult to do, and no one can consistently predict the direction of the market. Those that do manage to buy or sell at the perfect time on some occasion had one thing going for them - pure luck. But now, even more so, the market has become wildly volatile. Some of this can be attributed to those big problems that every body already knows about, like the ensuing global financial crisis - the devaluation of assets, a credit crunch, and a slowing world economy. But some of those wild swings in stock prices are also caused by a trickle-down effect of those big problems - such as how the masses of investors are reacting to these difficult economic times. Remember, stock prices really don't reflect the actual value of a company's stock, but rather the market's perceived value of a company's stock.

Human Emotion Contributes to Market Volatility.
For example, much of the stock market extremes in both bear and bull markets has been fueled by the human instinct to "follow the herd" and to do what everybody else seems to be doing. Investors often do this because they don't really know what to do on their own, so they assume the masses must be right and they jump on the bandwagon.

And to add even more fuel to the fire, the high speed at which information travels nowadays makes that herding instinct even easier to follow. The internet offers a vast world of knowledge, and a company's earnings reports, significant news, and industry rumors are instantly available to all. Information that may not have been widely heard about in the past comes straight to every investor on their computer. Knowledge is good, but too much knowledge of the relatively small stuff can become clutter. Investors may have difficulty processing all the info that comes their way, and as a group, will often over-react to a lot of that information.

And over-reacting has become easier and cheaper over the past decade or so with the increasing popularity of online trading. Back in the ol' days, a stock investor had to personally call their broker to place an order and paid steep commissions for the privilege. Those fees cut directly into the investor's profits or magnified their losses, and so the commission fee alone was often high enough to discourage investors' over-reaction to market swings. Now, it's easy to hop online anytime to check on investments, and the low cost of online transactions through a discount broker may encourage even long-term investors to fiddle around with their holdings when they hear or read news that they may not have been so quick to react to in the past.

Hedge Fund Redemptions Put Downward Pressure on Stock Prices.
Waves of investor redemptions of hedge fund shares are also to blame for some of the market volatility. Hedge funds, just like everything else, have performed poorly and many investors are scared and just want out. So hedge funds are being forced to liquidate their assets in order to meet their investors' demands to cash out, even if it means they have to sell investments at a loss. As hedge funds lose money, more investors will want out, and the downward spiral continues.

Also, since hedge funds have fewer restrictions than mutual funds and often take additional risks to increase profit, like short-selling, using options, or investing with borrowed money, it means that many of them will have to sell much more than the actual dollar amount of the redemptions. Many hedge funds are now carrying record levels of cash - somewhere in the area of 20% to 30% cash (and some hedge funds are even holding much more than that in cash) - in preparation for the wave of investor redemptions.

So as these massive hedge funds dump their shares to meet investors' redemption demands, the stocks those funds invest in will suffer - meaning that there will be good deals to be had. If you're already holding stock in these companies, it may be a chance to increase your number of shares at a discount, as long as the company's fundamentals remain strong. Hedge funds generally allow investors to redeem shares each quarter, so the mass redemptions are expected to continue in waves for at least the next six months. But some say that it may take up to two years to know how badly hedge fund redemptions will affect the markets.

Tip-toe Carefully in a Bear Market.
The upcoming months can offer great opportunity for the disciplined investor with a well-thought out investment plan of action. Carefully research your prospects, make investment decisions for the long-term, and be patient.

Often quoted are Warren Buffet's famous words, "Be fearful when others are greedy, and be greedy when others are fearful." Well, there's quite a bit of fear out there right now, so this sounds like a perfect time to take action that can really pay off in the long run. Going against the herd can be a little unnerving, but you may miss out on a great opportunity to grow your portfolio at a lower cost-per-share if you wait until the herd feels it's safe to turn the other direction.



Sources:
fool.com
International Business Times
seekingalpha.com
richard-wilson.blogspot