The Bear Market Double Whammy

Bear markets are tough not just because they radically shrink portfolio values but because they constantly try to entice investors to jump back into stocks too soon.

To put some statistical muscle on this view, I checked in with my friend Paul Desmond over at the venerable institutional research firm Lowry’s Reports for his latest supply-demand heuristics. He has continued all summer to recommend that investors steer clear of all rallies and use them to lighten up on their holdings.

Keep in mind that Desmond and his research team are by no means "permabears." They are just statisticians and historians who follow the data where it leads them.

I have been following their view of money flows for more than a decade, and they have simply done an outstanding job of helping clients understand the underlying buying and selling pressures on the market that are masked by the big-cap index values. These measures kept Lowrys’ clients out of most of the 2000-2003 bear market and put them back into stocks four days after the March 2003 low.

Desmond constantly warns that you have to steer clear of stocks until it is statistically clear that the supply of shares being offered for sale is drying up and that renewed investor demand is both broad and strong. (See also: "August Could Be The Tipping Point.")

He said this week selling pressure has risen to its highest level of the bear market so far, and buying interest has been so sluggish that upside volume and advance-decline line levels are flat even on days on which a flashy rally is staged.

The real problem with bear market rallies is that they usually end abruptly, wiping out a month of advances with a few days of selling. "Investors seem to rarely exit failed rallies as quickly as they got in, resulting in a series of whipsaws that can often compound portfolio losses," Desmond observes. So you must either decide to be very nimble during counter-trend rallies, or just resist the temptation.

Also he says we need to note that bear markets almost always reach their greatest intensity during their final months, when investor psychology has turned heavily negative, the news is one-sidedly negative and panic has begun to set in. With the rapid approach of the September-November period, which has contained some of the intense market declines in history, we should probably continue to view periods of rally as selling opportunities for anything risky in our portfolios.

I continue to believe strongly that we will know the bottom when we see it. We’ll see a massive decline, or series of declines, that tape off into a decline of selling pressure as the desire to dump stocks is exhausted—and then we’ll see one day in which the market rises by a huge amount in a single day on fantastic volume and breadth. We will likely miss that one up day, but if history and common sense are any guide, we will catch the rest of the bull market that follows.

In the meantime, continue to keep lots of cash on hand and invest or short opportunistically in the types of stocks and options that I recommend in Trader’s Advantage. (For details on how you can join, risk-free, click here now.)��

I wish I could be more like other advisors and tell you to ignore the bad news, but I can’t do that in good conscience. Let’s just wait this thing out together, and eventually we’ll be back in business enjoying all the great upside of a new bull market. (In the meantime, check out "Users Manual for a Bear Market.")

One of the few stocks that I have been recommending for purchase throughout this tough environment has been Covidien (COV), which closed at a new all-time high this week, giving my subscribers a 30% gain in the past 11 months. ��

The medical products giant announced this week that it’s launching a venture capital group, dubbed Covidien Ventures, to strategically invest in early-stage companies focused on medical devices, diagnostics and pharmaceuticals. COV has been been acquiring new products and companies at an aggressive pace since it spun out of Tyco last summer, so he move to establish an exclusive VC arm is right in line with the goals of its management team.

Covidien Ventures will be run by Daniel Sheehan, a former general partner at Affinity Capital Management in Minneapolis, and its new website says it will focus on investing up to $5 million in each round of early-stage financing while actively seeking seats on the boards of the startup companies it invests in.

Buy COV on dips only.

Jon Markman is editor of Trader’s Advantage and a regular contributor to InvestorPlace.com. To get this type of actionable insight from Jon and other InvestorPlace Media experts go to www.InvestorPlace.com today!