From bottom to top – March to May 2009 – the Dow Jones (DIA) has rallied 2,217 points or 34.43 percent. This pales in comparison to the 7,839 points lost up until the March lows.
A golfer asked to describe a 55 percent loss would probably be forced to use the analogy of a triple bogey or worse. Really, when it comes to investing, the same as when playing golf, keeping your “bogeys” (high percentage losses) at a minimum is the most important factor.
After the recent rally, investors are feeling once again thirsty for stocks, and unlike the past several months, confidence in the American dream is blossoming. In fact, the recent rally and so called economic recovery have been described a true “green shoots.”
One lesson investors should have learned over the past two years is that confidence comes before the fall. Enthusiasm about future prospects penetrated the pre-October 2007 market top atmosphere, the very beginning of 2009 and even the months leading up to the Great Depression.
The ETF Profit Strategy Newsletter observed back in December 2008 that extreme levels of investor optimism visible above Dow 9,000 will lead to new lows below Dow 6,700. That’s exactly what happened.
Even though the market has not reached extreme levels just yet, the writing is on the wall. Now is the time to compile a list of ETFs that should be sold at respectable levels. Volatile sectors like financials and discretionary along with leveraged ETFs should be the first ones to go.
ETFs tracking those sectors include the Financial Select Sector SPDRs (XLF) and Consumer Discretionary Select Sector SPDRs (XLY). Leveraged ETFs linked to financials include the Ultra Financial ProShares (UYG) and Direxion Daily Financial Bull 3x Shares (FAS). Broad market 2x ETFs like the Ultra S&P 500 ProShares (SSO) can also go south in a hurry.
According to ETFguide’s database, there are 39 leveraged ETFs linked to a variety of indexes. When the bear market resumes, you don’t want to be stuck holding any of them in your portfolio.
How long could the bear market continue, and how where is the ultimate bottom?
Only the market itself can provide the answer, and it will. Forecasts based on projected growth, GDP, etc., are just that, projections. Projections have to be adjusted as the underlying assumptions change.
A detailed analysis of long-term indicators like P/E ratios and dividend yields, however, shows that the market does not bottom until rock bottom levels are reached. Just like ice does not melt until the temperature goes above 32 degrees, the market does not bottom unless P/E ratios and dividend yields clock in at certain levels.
The March issue of the ETF Profit Strategy Newsletter contains a detailed analysis of P/E ratios, dividend yields and two other trusted indicators along with target levels for the ultimate market bottom. Know where the bottom is will prevent you from hitting yet another triple bogey.
Ron DeLegge is the San Diego-based publisher and editor of ETFguide.com is a frequent speaker and radio host on index investing. He also has been an investment and financial advisor and holds the Series 65 and 63 licenses.