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The Korean Times

Below is an article I was asked to write for the Korean Times. You are getting a first peak before it is published:

BEAR MARKETS AND WHAT TO DO

By: Mark S. Ballard

Executive Vice President

BankChampaign, N. A.

If you’ve opened your brokerage account or 401(k) statement recently, you likely noticed that the stock market fell off a cliff during October. It started in September, coincident with the various government interventions into our financial system, and gathered steam until the markets were down over 40% year-over-year.

This is a scary thing. No one likes to see their assets lose money, and it is human nature to want to end that sort of pain by selling the assets to stop the losses. Its natural, but its also wrong.

In the past 100 years, we have had five times when the stock market had a bear market with a greater than 40% price correction:

  1. In 1921, the market dropped 47%, then recovered to new highs just over two years later. It went on to increase by almost 500% between 1921 and 1929.
  2. From 1929 to 1932, the market dropped 89%, then increased 372% from the lows.
  3. In the bear market that ended in 1942 that saw a 52% decline in prices, the market recovered to new highs two years later.
  4. In the 1973 to 1974 bear market, we dropped 45%, which was recovered in two years time.
  5. In the 2000 to 2003 decline, the market dropped 50% but recovered all the losses within 3 years.

I know people lose faith in their judgment and start to second guess their decisions to be invested in equity securities. History, however, shows that if you hang on for the recovery you can recoup what you’ve lost during the correction.

To survive the correction and the recovery, just try the following:

  1. Don’t make rash changes to your portfolio – now is not the time to get more conservative, that was a year ago.
  2. Review what you own and ask yourself if the holdings make sense for the coming recovery (e.g., President-Elect Obama has an affinity for biotech companies based upon what he sold to be able to run for President – do you own some?)
  3. Do the companies you own have too much debt, decreasing cash flows or no macro-economic catalysts? If so, then think about making a swap to a company with no or little debt, strong free cash flow, or a catalyst for growth (e.g., strong sales to Asia’s growing middle class). Swap weak companies for strong companies, but don’t decrease your overall allocation to equity securities.
  4. Do the companies you own pay dividends? Historically, dividends have made up half the total return for an equity portfolio. If you need to swap into a company that pays dividends, look for one that is down with the market but that has a strong balance sheet, lots of cash on hand, has a dividend payout ratio less than 80% and a yield greater than 4%.

Once the market recovers, ask yourself this question: Am I comfortable with the risk associated with owning equities in my investment portfolio. You may figure out that you lost sleep during this correction and shouldn’t be 100% invested in common stocks. Maybe you should have a more conservative allocation that will allow you to mentally handle a severe correction.

If this is the case, look at a 65% equity and 35% fixed income allocation – this is the portfolio allocation that statistically has the highest potential return with the lowest amount of risk (as determined by volatility / standard deviation of returns). If you feel you need to sell, in the long-run you will be better off waiting until the market recovers and then repositioning your portfolio to a more conservative allocation at that time.

We will recover and as long as you own companies with strong balance sheets and cash flow, you will be able to weather this correction. In the meantime, hang in there and let history be your guide.