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Bear markets are always difficult to predict, but this one is straight out of The Twilight Zone. Barely a year ago, market watchers were wringing their hands over the reckless ascent of Chinese stocks; the profligate bond terms being extended to banana republics; the lust for all things emerging market. Surely, said the experts, a snafu in some far-flung place would bring the global stock market bull to its knees. The U.S., of course, would be the redoubt of quality.
Not quite. Foreign markets are swooning all right, but on fears over what's happening stateside. The supposedly steady U.S. market has been a basket case, dipping on Wednesday morning to 19% below its October high. (O.K., quibble if you must that the bear market threshold is 20%. But what's a percentage point among friends?) Despite the midweek rally, stocks are down a sickening 9% for the year.
This is what you need to know: We're in a bear market. Bear markets are painful. Some end quickly, others grind on for years. There's little use trying to predict what will happen or when, because full recoveries are apparent only in hindsight. Selling can be just as risky as buying, because there's no telling when an explosive rally will add 500 points to the Dow Jones industrial average in a day. Oh, and there are head fakes that will break your heart. (Like Wednesday's rally, perhaps.) "Personally, I don't think the real selling has even begun," says Robert Arnott, chairman of Research Affiliates, a Pasadena (Calif.)-based asset management shop. "The market only now realizes how seriously overexposed it was to loans and securities that should never have been made."
More worrisome, the sell-off is being driven by the so-called smart money—professional investors who manage big sums. This is no time, say some advisers, for retail investors to try to trade in and out of the swings. "It's a treacherous landscape," says Chris Whalen of Institutional Risk Analytics, a risk management consultancy. "The little guys always get hurt when they try to outguess the market." Some advisers think retail investors should ignore all of the old nostrums right now. "Buy and hold' should be thrown in the dustbin," says Steven Lehman of Federated Investors (FII), who predicts the stock market slump will last "for the foreseeable future."
But tempting though it may be to give in to the gloom, January isn't a foolproof predictor of things to come. The five worst January swoons since 1926 led to an average gain of 12.3% over the following 12 months and 26% over the next 24 months. What's more, bear markets often produce big gains down the road.
For now, confusion reigns as pros grapple with the snarling bear. Some, like Scott Armiger of Greenville (Del.)-based Christiana Bank & Trust, are sticking with textbook responses to slowdowns: buying into defensive sectors such as consumer staples and health care.
Others are tweaking their approaches based on the global economy. John Boich of Security Global Investors and Paul Blankenhagen of Principal Global Investors (PFG) both figure a U.S. slowdown will crimp growth overseas. Blankenhagen has been exiting European retail stocks and other companies exposed to consumers. Boich is looking for investments that will be insulated from a global slowdown, such as Hong Kong real estate and Japanese regional banks. Japan, he notes, is nearly through its housing bust and isn't facing the same credit crunch as in the U.S. And India has a domestic growth story: It doesn't rely only on exports to the U.S. "For those who missed India the first time around, take a close look right now," he says.