Should savvy investors consider departing the stock market altogether?
David Dreman, chairman and founder of Dreman Value Management, doesn't think so, as long as those investors don't try to be too clever and wind up outsmarting themselves.
"You don't see market timers who own yachts," Dreman writes in Forbes magazine.
"If you pack up now, chances are you'll miss a good part of the next bull market."
However, Dreman says, most analysts' estimates for both the second half of this year and the first half of 2009 are way too optimistic.
"They're predicting year-over-year earnings gains in both periods for the S&P 500, when in all probability there will be drops," Dreman says.
"If there is no further fall in stock prices, the price-to-earnings ratio of the S&P is going to move higher."
Dreman points out that the liquidity crisis that continues to unfold is proving far worse than the most pessimistic observers expected. In addition, a second wave of writeoffs is occurring in lockstep with markdowns by mid-size banks that hold large burdens of construction and real estate loans.
The government is under intense pressure to avoid more Bear Stearns-type bailouts, but a run on another big investment bank could lead to panic. Trillions of dollars in derivatives guaranteed by investment bankers, banks, and hedge funds would be threatened with collapse.
"A single big investment bank's default might make its competitors seize up too, since nobody can unravel who owes what to whom," Dreman says.
Dreman does see a big potential for economic gain in all this.
"If the market slide continues, you will get opportunities to buy first-rate companies when they dip on negative news, such as an earnings miss that analysts and investors overreact to," Dreman points out.
"When that happens, you should sell less-promising stocks to raise cash to buy the companies the market has panicked on."
The lion's share of bull market gains are always made during the first few months after the bear loses power when market-timing investors are still sitting on the sidelines, Dreman says.
Given that this is an election year, he expects that more help will be forthcoming Congress, and that the Fed will raise interest rates to fight inflation.
"Raising rates usually hurts the markets at first, but over time stocks have been one of the best inflation hedges you can find," Dreman says.
Bear markets are the hardest kind to invest in, Dreman acknowledges, but they can also be the most rewarding.
"If you don't already own any oil and gas explorers, buy some shares now," Dreman recommends.
Some companies that have strong fossil-fuel reserves are trading at multiples of their trailing earnings that are below the S&P's multiple of 15, he notes.
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