Surviving the down market and coming out as the winner

A Case Study: 2000-2002 Bear Market
Consider the bear market that occurred between the spring of 2000 and the fall of 2002, often referred to as the "tech bubble" or dotcom bubble. As the monikers suggest, the problems in this market began with technology stocks, as evidenced by the more than 60% drop in the tech-laden Nasdaq index. But weakness in a few sectors quickly spread, eventually dragging down all corners of the equity map. Even the blue-chip Dow Jones Industrial Average (DJIA) fell over 25% during the period.

Leading up to the year 2000, the explosion of the internet led to dramatic innovations in all areas of technology, including data servers, personal computers, software and broadband transmission systems like fiber optics and cable. By the late 1990s, any company remotely involved in the internet had a sky-high market cap, giving it access to very cheap capital. Stocks with little or no earnings were suddenly worth billions, and used their stock currency to buy other companies, obtain bank credit and expand operations.

Meanwhile, non-tech based companies felt the need to get caught up technologically, and spent billions on equipment as well as activities related to "Y2K" preparation, further inflating demand for tech products, but it was an artificial demand that could not be supported over time.

The Snowball Effect
As always happens near the peak of a bubble or bull market, confidence turned to hubris, and stock valuations got well above historical norms. Some analysts even felt the internet was enough of a paradigm shift that traditional methods of valuing stocks could be thrown out altogether. But this was certainly not the case, and the first evidence came from the companies that had been some of the darlings of the stock race upward – the large suppliers of internet trafficking equipment, such as fiber optic cabling, routers and server hardware. After rising meteorically, sales began to fall sharply by 2000, and this sales drought was then felt by those companies' suppliers, and so on across the supply chain.
Pretty soon the corporate customers realized that they had all the technology equipment they needed, and the big orders stopped coming in. A massive glut of production capacity and inventory had been created, so prices dropped hard and fast. In the end, many companies that were worth billions as little as three years earlier went belly-up, never having earned more than a few million dollars in revenue.

The only thing that allowed the market to recover from bear territory was when all that excess capacity and supply got either written off the books, or eaten up by true demand growth. This finally showed up in the growth of net earnings for the core technology suppliers in late 2002, right around when the broad market indexes finally resumed their historical upward trend.

Start Looking at the Macro Data
Some people follow specific pieces of macroeconomic data, such as gross domestic product (GDP) or the recent unemployment figure, but more important are what the numbers can tell us about the current state of affairs. Bear markets are largely driven by negative expectations, so it stands to reason that it won't turn around until expectations are more positive than negative. For most investors - especially the large institutional ones, which control trillions of investment dollars - positive expectations are most driven by the anticipation of strong GDP growth, low inflation and low unemployment. So if these types of economic indicators have been reporting weak for several quarters, a turnaround or a reversal of the trend could have a big effect on perceptions. A more in-depth study of these economic indicators will teach you which ones affect the markets a lot, or which ones may be smaller in scope but apply more to your own investments.

Position Yourself For the Future
You may find yourself at your most weary and battle-scarred at the tail end of the bear market, when prices have stabilized to the downside and positive signs of growth or reform can be seen throughout the market.

This is the time to shed your fear and start dipping your toes back into the markets, rotating your way back into sectors or industries that you had shied away from. Before jumping back to your old favorite stocks, look closely to see how well they navigated the downturn; make sure their end markets are still strong and that management is proving responsive to market events.

Parting Thoughts
Bear markets are inevitable, but so are their recoveries. If you have to suffer through the misfortune of investing through one, give yourself the gift of learning everything you can about the markets, as well as your own temperament, biases and strengths. It will pay off down the road, because another bear market is always on the horizon. Don't be afraid to chart your own course, despite what the mass media outlets say. Most of them are in the business of telling you how things are today, but investors have time frames of 5, 15 or even 50 years from now, and how they finish the race is much more important than the day-to-day machinations of the market.

Truth be told, there are no safe sectors of the market now. Even the darling of recent couple years, Energey, is due for a correction due to mounting political and economic pressures. The safe play right now would be to buy index funds that track either the Dow or Nasdaq. Try the Ultra ETFs such as DDM or QLD, they return twice as fast as the index returns. Unless U.S. slips into a depression, which is very unlikely, investing in the Dow or Nasdaq index now should see a profit in a quarter or two.