Falling Prices can be a double-edged sword

Risk is more often in the price you pay than the stock itself.

Markets have fallen time and again because of some political or economic announcement.  Similarly, individual stocks and sectors often fall on weaker than expected earnings or unforeseen events.

During market sell-offs, the rapid decline of prices brought bargain issues that an investor could buy for a lot less than their pre-collapsed prices.

As others are selling in reaction to news reports, you can load up with value opportunities that can benefit from the subsequent price recoveries.  It is important to understand that the prices of solid companies with strong balance sheets and earnings usually recover.  If the fundamentals are sound, they always have and they always will.

From 1932 to today, the studies confirm that when bad things happen to good companies, they recover and usually quite nicely in a reasonable amount of time.  It has also been shown that high performance seems to beget lower returns, and low performance leads to higher returns in nearly all markets.  Today's worst stocks become tomorrow's best stocks and vice-versa.



Catching a falling knife

There is danger in trying to catch a falling knife, but even when stocks dropped 60% in one year, and bankruptcy and failure rates jumped fourfold, opportunities abounded.

Remember that one of the chief tenets of the value investing approach is to always maintain a margin of safety.  You can lessen the chances of buying a failure and increase your portfolio performance if you stick to the principle of margin of safety.  Don't try to catch an overpriced, cheaply made falling knife.

When stock prices fell after the bear markets, many investors were decimated.  On the other hand, value investor like Warren Buffett, was thrilled with all the bargains he found as a result of the collapse and said now was the time to invest in stocks and get rich.  The average investor and many professionals, having suffered through a bear market, wanted nothing to do with stocks and missed out on the chance to load up at these low prices.

You just had to catch the babies being thrown out with the bathwater.


Summary:

1.  Buying stocks that have fallen in price and yet still offer a margin of safety has resulted in successful investments.

2.  Although many find it difficult to leave their comfort zone and buy stocks that have fallen, those of us buying cheap stock realise that the bargains are found in the sales flyers and the new low lists, not in the highfliers (popular stocks) and the new high lists.





Examples:

Bear market of 1973 to 1975 Crash of the Nifty Fifty
The stock prices fell an average some 60% and many investors were decimated.  Warren Buffett in an interview with Forbes in November 1, 1974, described himself as feeling like an "oversexed guy in a harem".


1980s
Some of the large public utilities in US overcommit to nuclear power with disastrous financial results and fell into financial difficulty.  Many of them even had to file for bankruptcy to work out their difficulties.  After the Three Mile Island accident, the world interest in US nuclear power practically ground to a halt.  Few portfolio managers or individuals wanted to invest in these companies.  But those brave few who invested in Public Service New Hampshire, Gulf States Utilities, and New Mexico Power ended up with enormous returns over the balance of the decade as the  companies worked out their problems and returned to profitability.


Late 1980s and early 1990s
The fall of Drexel Burnham, the junk bond powerhouse and the implosion of the high-yield debt market, along with collapsing real estate prices, caused what is now know as the savings and loan crisis.  This crisis spread from the smaller S&Ls to the largest banks in the country.  Venerable institutions such as Bank of America and Chase Manhattan Bank fell to prices at or below their book value and had price-to-earnings ratios in the single digits.  Wells Fargo was hit particularly hard because it appeared to have significant exposure to a rapidly declining California real estate market.  Investors who did their homework and invested in banks during this time earned enormous returns over the decade that followed as the industry went through a merger boom that generously rewarded shareholders.  You just had to catch the babies being thrown out with the bathwater.


1992
After Bill Clinton took office, he appointed his wife Hillary to head a committee on health care reform that proposed a drastic program that would have dramatically, curtailed the profits of the pharmaceutical industry.  All the leading drug company stocks declined sharply.  Companies like Johnson & Johnson, fell to a level of just 12 times earnings.  Most investors shied away from the industry.  Investors who saw the opportunity in Johnson & Johnson realised that the stock was selling for the equivalent value of the consumer products side (Band-Aids and Tylenol) of the business.  You got the prescription pharmaceutical part of J&J for free.  Once Hillary care was a ded issue, the stock of J&J and the other pharmaceutical companies brought outsized gains to investors willing to take the plunge.


9/11 disaster
After the disaster of 9/11, American Express was viewed as being too dependent on air trael, and its shares fell from the ppprevious year's high of $55 to as low as $25.  Although American Express may have been facing some travel-related struggles, it was an enormously profitable company that sold at just 12 times earnings.  Investors who realized that companies of this quality are rarely this cheap and that the income stream from the credit card business offered a margin of safety have been amply rewarded in the years since.  American Express is another example of how catching the right falling knife can sharpen returns with high-quality stock at low prices.

How to make money in a down market?

Here is an example of making money in a down market.

At the end of 2007, an investor was enthusiastic about a stock ABC.  Then the severe bear market of 2008/2009 intervened.  Here were the investor's transactions in stock ABC.

1.11.2007  Bought 1000 units  @  $6.00          Purchase value  $6,000
6.11.2007  Bought 1000 units  @ $ 6.75          Purchase value  $6,750
15.9.2009  Bought rights 800 units @ $ 2.80    Purchase value  $2,240
!5.9.2009   Bought 5,500 units  @ $ 3.51         Purchase value  19.305

Total bought 8,300 units
Purchase value  $34,295
Average price per unit $ 4.13

Current price per unit  $ 5.51
Current value of these 8,300 units is $ 45.733.

This is a total gain of $ 11,438 or total positive return of 33.4% on the invested capital, excluding dividends, received for the investing period..


Lessons:
1.  Investing is most profitable when it is business like.
2.  Stick to companies of the highest quality and management that you can trust..
3.  Stay within your circle of competence.
4.  Invest for the long term.
5.  Generally, hope to profit from the rise in the share price.
5.  At times, the share price becomes cheap for various reasons # - be brave to dollar cost average down, provided no permanent deterioration in the fundamentals of the company..


# Severe bear market of 2008/2009.

Nouriel Roubini 2009 - Stock Market Calls

Back Peddling Bears
There is a reason bears such as Nouriel Roubini, David Rosenberg, and now Doug Kass are offering a more tame outlook. The data doesn’t support an all-out economic collapse.

For the record, we are not bulls. We see a lot of major problems in the global economy. However, we see a much more mixed picture than the apocalyptic bears who seem to have blinders on when it comes to anything disproving their case.

A recovery starts slowly. First companies cut costs. Then they spend. Then they hire. Then the economy heals. Seems like the first two phases are taking root.

Do you think the economy is about to fall off the cliff? Do you think we are amidst a textbook recovery? Is it more complicated than that? Let us know in the comments below …

U.S. economy: From Recovery to Sustainable Growth

July 15, 2010, 10:21PM EST

Analysts Pare Revenue Growth Expectations

Investors may not be able to count on robust rates of sales growth to boost earnings in coming quarters

By David Bogoslaw

Equity analysts and investment strategists have been closely watching corporate revenue trends since last summer to see what's driving any improvement in earnings. But investors may not be able to count on improving sales growth as a way to pump up profits: Analysts are dialing back expectations for revenue growth for some of the world's biggest companies.

In a July 13 market commentary, Nicholas Colas, chief market strategist at BNY ConvergEx Group, an investment technology provider, published data showing that analysts' consensus revenue estimates for the 30 stocks in the Dow Jones industrial average for the second, third, and fourth quarters of 2010 have been declining since April or May. Forecasts were lower in July than in April or May for 21 companies of the Dow 30 for the second quarter, for 22 for the third quarter, and for 19 for the fourth quarter, the report said.

The trend toward lower revenue expectations is present in the broader market. In the three months leading up to July 15, 48.7 percent of companies in the Standard & Poor's 500-stock index with available data had their revenue estimates cut, vs. 39.3 percent in the comparable period leading up to Apr. 30 and 37.1 percent in the three months leading up to Jan. 29, according to Bloomberg data. The start of fourth-quarter earnings releases is typically mid-January, while first-quarter earnings are released beginning in mid-April.

Colas has been tracking analysts' projections for revenue growth for the past year and says that until April those numbers had continued to climb "every single month, month in and month out," reflecting analysts' expectations for further improvement in quarterly earnings. But the trend over the past two months has flattened and is now declining. That's coincided with an 8.0 percent pullback in the S&P 500 index between Apr. 15 and July 15, and Colas believes there's a link between the two.

"For the first time since the [March 2009] market lows, analysts now realize they have overshot on revenue expectations and now are starting to pull them back in," he says. "Earnings expectations have not declined, so analysts have cut revenue expectations but have given companies more credit for [continuing] cost cuts."

IMPACT ON STOCKS
Doubts about the strength of revenue growth over the past year could pose problems for continuing advances in stock prices. "What do you pay for earnings if you're not sure what the structural growth rates are? That's a big, big question," says Colas. "One proxy for structural growth is revenue growth."

While two-thirds of the 30 Dow components seems like a large proportion, the index contains a lot of blue chip companies whose sales are highly correlated to U.S. gross domestic product, says Jeffrey Kleintop, chief market strategist at LPL Financial in Boston. As GDP projections for 2010 have moderated, it makes sense that consensus estimates for revenue growth would follow suit, he says. On July 14, the Federal Reserve lowered its economic growth estimate for 2010 to 3 percent to 3.5 percent from a forecast of 3.2 percent to 3.7 percent given in April.

It's fair to wonder whether the increasing percentage of downward revisions reflects the extent to which analysts may have been blindsided by the European sovereign debt crisis and the slowdown in China, not to mention the soft patch that the U.S. economy has hit. It may be that analysts' optimism about economic growth at the start of a new year tends to fade as the year wears on, which is borne out by patterns in 2009 and so far in 2010, says Peter Nielsen, manager of the Sextant Core Fund (SCORX) at privately held Saturna Capital in Bellingham, Wash.

Another thing to keep in mind: "There's a lot of noise" in the year-over-year comparisons for revenue due to the absence of growth drivers such as cash for clunkers and other government stimulus programs that boosted companies' sales in 2009, says Nielsen. That may be one reason for the conservative revenue numbers coming from many brokerage analysts, he adds. Nielsen thinks year-over-year comparisons will become more difficult as the year progresses and expects "very modest" revenue gains in the third quarter.

It also makes sense that analysts would be paring their revenue estimates around the one-year anniversary of what most economists agree was the bottom of the economic cycle, says Craig Peckham, equity product strategist at Jefferies & Co. (JEF). It's logical to conclude that revenue growth will disappoint investors as year-over-year earnings comparisons become more challenging later this year, he says.

REASSURING EARNINGS REPORTS
The central issue is that investors are unwilling to pay as much for earnings growth driven more by cost-cutting than by improvement in sales. "What you pay for an earnings multiple for cost-cutting is less than what you pay for revenue growth because cost-cutting has to stop somewhere" while revenue growth has "a longer runway," says Colas.

Encouraging second-quarter earnings reports may be enough to stanch the flow of negative revisions and confirm the view that analysts have reduced estimates too far on concerns about Europe, as well as doubts about consumer spending in the U.S., says Jefferies' Peckham. The performance of some equity market bellwethers seems to suggest that analysts may be relying too heavily on pessimistic macroeconomic data that have come out in the last two months, he adds.

Alcoa (AA) reported earnings of 13 cents per share on July 12, beating the Street's forecast by a penny, on a 22.2 percent rise in revenue from a year earlier. On July 13, Intel (INTC) posted a profit of 51 cents per share, up from 18 cents a year earlier and beating analysts' expectations by 8 cents. The microchip manufacturer's revenue rose $2.7 billion, or 33 percent, from a year earlier, exceeding the consensus forecast by $549.9 million, or 5.5 percent. Intel projected third-quarter revenue of $11.2 billion to $12 billion, the lower range of which was ahead of the consensus estimate by $289.35 million, or 2.7 percent, a day prior to the earnings release.

In making the transition from recovery to sustainable growth, the U.S. economy faces some key obstacles such as Europe's fiscal problems and the weak domestic labor market, according to a midyear outlook report by LPL Financial published on July 12. While U.S. banks are fairly insulated from European debt woes, LPL said that U.S. exports and business spending are vulnerable to a pullback in global economic growth that could result from another freeze of liquidity and trade, as well as to the euro zone slipping back into recession due to cuts in government spending, tax hikes, and higher borrowing costs.

TYPICAL RECOVERY SLOWDOWN
Kleintop thinks analysts were caught by surprise by negative macroeconomic data on home sales, retail sales, and job creation. That's not unusual since analysts tend to focus more on microeconomic data related to companies they cover than what's happening in the broader economy. But the fact that the economy has hit a soft patch a year into the recovery is typical of each of the past several recoveries, he says. Each time, the soft period didn't halt the expansion, but it did slow the pace of economic growth and result in a flat stock market for about a year, he says.

Another source of confusion for the market is the divergence between robust manufacturing data and a resurgence of caution among consumers. While the manufacturing strength is encouraging, that's a small part of the economy relative to consumer spending, which accounts for roughly 70 percent of GDP. The fact that the dominant sector is so sluggish "makes this recovery somewhat fragile and susceptible to a downside shock," says David Joy, chief market strategist at RiverSource Investments. He thinks consumer spending will probably remain soft, making a 3.0 percent gain in GDP the best the U.S. can muster for the foreseeable future.

It's worth noting how questions about economic growth have been translating into stock performance, he says. "We're noticing valuations within the market are very compressed. Investors are saying large caps are no better than small caps, that high-quality stocks are no better than low-quality ones," he says. "That tells us where you want to be is in large-cap, high-quality stocks," which have more reliable earnings growth and tend to pay dividends and aren't selling at a premium to lesser-quality names as they usually would.

But by focusing on revenue growth, investors may be overly conservative in their outlook for earnings growth. U.S. companies slashed costs dramatically at the bottom of the cycle, paving the way for outsized earnings growth once revenues recover even modestly, says Peckham. "Companies have been able to create cost structures with a ton of operating leverage. If you've got a model with good operating leverage, your earnings should go up a lot faster than your revenues," he says.

CORPORATE OUTLOOK WATCH
Second-quarter earnings, which have just begun to be reported, are likely to ease market jitters as key economic questions such as the impact of Europe's debt and growth problems are put in perspective, says Kleintop. Although many companies in the S&P 500 export goods and services to Europe, most of the demand from overseas in the past year has come from Asia. Large U.S. companies can still generate strong double-digit profit growth without help from Europe, he says.

Saturna's Nielsen is particularly eager to hear comments from pharmaceutical executives on earnings conference calls to get a sense of the impact they expect fiscal austerity measures in Europe to have on their European sales. He's deeply skeptical of the confidence sell-side analysts have in European governments' willingness to continue to pay up for drugs and joint replacements based on aging demographics in those countries, in the face of their fiscal difficulties.

Conference calls should also provide more clarity on the tangible costs of health-care and financial reform as companies disclose what they think the impact of these regulatory changes will be on their businesses, says Kleintop. "Once you can define them, they start to lose some of their potency to sway sentiment," he says. That could help sustain the recent stock rally. While the market seems stuck in a broad range, he says the S&P 500 could see further gains of 5 percent to 7 percent before another round of profit-taking kicks in.

The increasing number of downward earnings revisions doesn't bode well for stock market gains in 2010 relative to 2009. Roughly 200 companies in the S&P 500 have had downward revisions in the past three months, vs. 250 that have had upward revisions, according to data that Kleintop has been watching. Three months ago, only 150 companies had had downward revisions vs. 300 that had had upward revisions. The percentage of total analyst revisions that are positive "moves in lockstep with the year-over-year performance of the S&P [500 index]" going back 30 years, he says.

The steam that's come out of revenue growth expectations makes the 2011 consensus forecast for aggregate earnings of $96 per share for the S&P 500 look less and less realistic, says RiverSource's Joy. With the broad market now trading at around 12 times that number, even if you scale revenue growth back slightly, stocks still seem inexpensive, he says. That makes him think there's a cushion for equities even if revenue growth isn't robust enough to generate the earnings analysts are expecting.

Bogoslaw is a reporter for Bloomberg Businessweek's Finance channel.

http://www.businessweek.com/print/investor/content/jul2010/pi20100715_477248.htm

But a bear market isn't all bad news.

Sure, it can hurt when your portfolio takes a hit when stock prices fall. But you'd still better be prepared for the inevitable downturns in the stock market, and remember that the situation is only temporary, after all. In every instance when the overall market dropped, it returned and then grew to greater heights. In fact, the stock market has a 100 percent success rate when it comes to recovering from a bear market! The only thing to remember is that sometimes it takes longer for the bounce-back to occur.

If you follow a long-term approach to investing, then you know that patience is a virtue whenever you're investing in the stock market. It also helps to keep your vision focused on your long-term horizon whenever the market hits some turbulence. By using dollar cost averaging and by investing regularly, you can even make the bear market work for you by taking advantage of generally lower prices with additional purchases. Knowing the market's infallible past record, you can sleep easy -- even when other investors are panicking.

The Bull Market that followed the 1956-1957 Bear Market

http://www.businessinsider.com/bear-market-1956-1957

Post Bear Market Recoveries (Australia)

http://spreadsheets.google.com/pub?key=twOYrUjYPau2adIivkDDotg&output=html


Source:
The fight is on for profits
http://www.smh.com.au/news/home/business/money/investment/the-fight-is-on-for-profits/2010/01/26/1264267986069.html?page=fullpage#contentSwap2