Looking Past the Tug-of-War, Our Strategy For 2009

The New Year started off in fine fashion, as stocks rang in 2009 with a first rate fireworks display. The reasoning behind the 550 point blast seen during the last two sessions of ’08 and the first day of ’09 was that traders were looking ahead to brighter days on the back of the Obama stimulus plan, which, at first blush, sounded like it would get this thing turned around.

But with the economic data having been mind numbingly bad so far this year and the earnings downgrades now the most negative on record, it appears that reality may have returned. The bottom line is last week’s -4.8% decline in the DJIA reversed the recent optimism and put any thoughts of stocks breaking higher on the back burner. Thus, any giddiness over the potential for more upside surprises is now gone as stocks have settled back into the familiar pattern that has been in place since the middle of November.

So, what should we make of the action thus far? In short, it would appear that we’ve got a colossal game of Tug-of-War on our hands, which isn’t likely to end soon.

Tough Sledding For A While

The general consensus at the moment seems to be that 2009 will be a year with two distinctly different faces. Most everyone expects the first half to be a ‘more of the same’ type of affair as the battle between the current dour economic reality and hope for the future rages. According to the prognosticators, this up-and-down action will eventually give way to a cyclical upswing sometime down the road as the enormous efforts expended by the Fed, the Treasury, and the incoming administration is expected to begin to pay off. But until we start to see signs of actual improvement, it might be a rough road.

Three Keys To Success In 2009

In our humble opinion, there will be three keys to success in 2009. First, it will be critical to avoid “screwing things up” during the tug-of-war period. Next, we need to understand that Ms. Market will likely provide us with a tremendous opportunity to make some money during a cyclical uptrend sometime this year. And finally, the last trick to make your portfolio shine in ’09 will be to know what to own and maybe more importantly – know what NOT to own.

Don’t Give Up Too Soon

We stated that the first goal of ’09 is to not screw things up before the fun starts. What we mean here is that investors need to have some patience and a good grasp of the big picture as we slog through the next couple of months. Yes, things ARE going to get better at some point in 2009 and there WILL be opportunities to make money! But, we must understand how the cycles work and that things may get worse (or at least, feel worse) before they improve.

The big point here is if things play out as they have in the past, it may be all too easy to throw in the towel at exactly the wrong time. Currently, it is fairly easy to look ahead to brighter days. But, after a couple of months worth of what is likely to be miserable earnings reports and a steady diet of really lousy economic data, there is a decent chance that the major indices will find themselves lower than they are today. This is not a prediction mind you, but rather an effort to prepare ourselves mentally for what MAY occur.

Therefore, the trick will be to keep the big picture in focus. And remember, you can predict direction or timing, but not both. So, while we feel confident that there will be stellar opportunities or two to make money in 2009, we won’t go so far as to say when they will arrive. Thus, we need to stay focused on the action and remain patient/defensive in the early going.

Getting The Timing Right

If things play out as they have in the past, our “Crash Playbook” says we should be on the lookout for three things going forward:

• The End of the Dive: Over the past 6 months, we have witnessed a ‘slow motion crash’ or what is commonly referred to as a Waterfall Decline. So, the first thing we need to identify is the bottom of the crash. The good news is we can make a check mark here as we believe we saw the low of the decline on November 20th at Dow 7552.
  
• The Bear Market Bottom: This may sound like a redundant term. However, the difference between the end of the waterfall decline and the bear market bottom is the testing and retesting of the lows. In short, after a low has been put in plance and then tested a time or two, we can usually declare an end to the decline. This usually takes place within a couple of months of the end of the waterfall decline.
  
• The End of the Recession: While identifying the end of a recession requires a great deal of hindsight, Ned Davis Research tells us that on average, the end of a recession occurs three to four months after bear market bottoms.

So, probably the most important move in 2009 will be anticipating the cyclical upswing that accompanies the market’s ‘discounting’ of the recession’s end. This type of move has historically produced gains in the 25% - 50% range. And while this rally may not signal the end of the bear market, it will likely provide a very good opportunity to “make the year.”

Owning The Right Stuff

Finally, while this concept isn’t specific to this year alone, the idea of having your portfolio in the right stuff is likely to be more critical than normal in 2009. But unfortunately, most of the analysts getting all the airtime on T.V. these days are talking about the wrong stuff.

Think about it; has anyone come on CNBC and talked about increasing your beta in the next couple of months? Has anybody talked about the heading to the emerging markets in 2009? And has there been a single commentator talking about investing in more aggressive sectors?

The answers are no, no, and no! Just the opposite is occurring as just about every talking head continues to yammer on about owning the consumer staples and health care sectors because they tend to hold up better during a recession. Well folks, we should remember that we’ve been in a recession for 13 months now and the days of the “defensive plays” are likely numbered.

The trick to being successful in this type of environment is to anticipate what is coming down the pike – not focusing on what has already happened. So, once again, we will turn to the computers at Ned Davis Research for some help on what is likely to shine in ’09.

The historical results are actually quite surprising as the favored sectors such as consumer staples, telecom, utilities, and health care have all UNDERPERFORMED from the time bear markets have bottomed until the end of a