Stocks Near Bear Market, But There's No Panic—Yet

As stocks move near a full-fledged bear market, you might expect a lot of fear from investors.


You'd be wrong.

Rather than panic, investors are primarily just sitting out the near 20% declines in the three major indexes that constitute a bear market.

They're holding on to more cash, taking advantage of the commodity boom and rebalancing portfolios to make sure they're well diversified.

But panic? No, not yet at least.

"The people we deal with have been very calm in this environment," says Dennis J. Barba, managing partner of the Oxford Group of Raymond James Investments. "The selloff seems to be pretty orderly. I haven't seen the individual investor, the average person, panicking."

The Dow briefly passed a 20% decline Friday afternoon, then closed just short of that mark. Both the S&P 500 and Nasdaq are close behind. Mearnwhile, market experts are calling for perspective.

A Few Key Factors

That may be because the precipitous drop in stocks has been primarily triggered by just a few key factors, including a further unwinding in the credit crunch that has seen large investment banks take huge writedowns, after the market hoped the worst had passed.

The result has been Wall Street buzz that other big banks are in trouble.

Financials are taking an almost daily beating, with shares at Citigroup and others hitting multi-year lows. Lehman Brothers , itself the subject of intense scrutiny about its cash position, estimated higher writeoffsfor Merrill Lynch than originally thought, setting off a fresh round of speculation that another Wall Street giant was headed for Bear Stearns-level trouble.

"Your financial stocks are getting pounded," Barba adds. "They were such a heavy component of large-cap indexes and that's driving the market down. We've still got a lot of uncertainty with the banking system."

The other big factor has been energy.

With oil prices soaring market-watchers were concerned about the health of the consumer. Yet fresh economic numbers released Friday showed that government stimulus checks helped boost consumer spending by numbers not seen in years.

"In the backdrop of what we're looking at, with enormous spending in Iraq, ridiculous oil prices, a near collapse of the financial markets, it's not really all that bad," says Michael Kresh, president of M.D. Kresh Financial Services.

"It's a perception issue," Kresh continues. "If I were to sit down with you last year and describe what's going to happen in the next 12 months, we would all be agreeing that the market would be down 30 to 40 percent and it would be an unmitigated disaster. But what we're seeing is a problem, not a crisis."

Panic at the Pump, Not Portfolios

To be sure, a crisis would entail high-volume selling and sharp increases in panic indicators, like the Chicago Board Options Exchange's Volatility Index. But the Vix has remained relatively benign, in the mid-20s area that suggests only moderately high volatility, and other indicators have stayed in check as well.

"When you look at other selloffs where you reached the bottom, invariably they coincided with the indices that measure fear and measure downside risk moving up and moving up substantially. We haven't seen that," says Quincy Krosby, chief investment strategist at The Hartford. "History tells us that typically the bottom of markets coincide with huge, huge selling pressure."

So while financials indeed are selling off and taking other individual stocks with them, there's been no widespread sentiment toward dumping equities broadly.

Instead, most portfolios are now weighted stronger than usual in cash positions like bonds and money market accounts, and are using commodities like oil and grains to hedge against further downside and inflation risks. Diversification is the watchword at a time like this.

It's a formula that's worked well for Kresh and his clients who are not cowed by fears of a bear market.

"These numbers are thrown around by technical analysts and they do have an impact on the market, but the issue here is that we have to look forward beyond the current problems and see how they are going to resolve," he says.

Kresh says putting his clients in commodities, oil particularly, helps ease the pain at the pump when they know their investments are benefiting from the oil surge.

Barba keeps his clients largely in cash positions nowadays, preferring municipal bonds and some taxables depending on how the analysis bears out.

Uncertain times are dictating some investors to be content to increase their positions in low-yielding money markets and certificates of deposit, even though they are actually losing money, Krosby says.

"When investors feel they have no control over something they are prepared to put money in instruments where inflation every day is eating at those returns," she says. "They don't see it that way, they see it as protecting their money."

Krosby says there is another factor pulling down the markets: End-of-quarter maneuvering by hedge fund investors who have the chance to get out of their positions, and managers of the funds looking to raise capital.

Krosby still looks for the market to find a bottom soon, but believes it will need a catalyst to do so. Second-quarter earnings outlooks will be key, she says.

Until then, investors will tread carefully.

"The more the market pulls back, the more opportunities arrive," Krosby says. "It's a time to be cautious, but it's also a time where when we have reached bottom something can come along and move the market up."