Ask Colin

I have been making a transition from buying mutual funds on a long term basis to buying stocks on a short term basis and selling short a little bit. I assume we are now (December 2000) in the phase 2 of a bear market. Would you advise me to sell my mutual funds now and do you have any other recommendations to help me with my transition?

First, lets us deal with the market. I have just written an article for a magazine on this and you are also not the only one to ask me recently. As I see it, the Nasdaq stocks are the bubble sector that drove the excesses of the bull market in the 1990s. The wealth it created also drove the economy generally and therefore the other sectors of the economy were also carried up in the bull market. While the Nasdaq stocks were wildly over valued, it is still true that so were the other sectors, though to a lesser extent. What I think will happen therefore in a bear market is that the Nasdaq stocks will be hit really hard, but so will the rest of the economy. It follows that the losses in the bubble sector are likely to depress everything.

At this point I see earnings downgrades for Nasdaq stocks and this is a sure signal that the wild hopes that drove the bubble are being abandoned. So, we have clearly moved into phase one of a bear market. Whether we are in phase two yet is open to discussion. It broadly calls for actual earnings decreases (or greater losses from bubble stocks that have never made a profit). So far they are telling us profits will be down, but that has not actually occurred yet - A fine point perhaps, but I think there is a lot more of phase two to be played out yet.

I also think that, while bear markets tend to be shorter than bull markets, they also tend to a length in proportion to the bull market before them. We have had a very long bull market. I expect therefore a longish bear market - years rather than months. However, this is all just speculation and gut feel. The only key is to watch what happens and adjust strategy to what you see. The point is not to mistake the sharp rallies that occur in all bear markets for the start of a new bull market. Psychologically, bull markets do not start until most people believe it is just another rally in the bear market.

So, that is where I think we are. As for strategy, a trader should not now be holding any stock that is not still in an uptrend. Eventually, such a strategy will take us right out of the market. An investor, on the other hand, should have increased cash holdings by selling all bubble stocks and stayed only with defensive positions - good stocks, that are not overvalued and not in down trends.

Secondly lets examine what you seem to have been doing and that is moving from investing to trading. You have to recognise that you have been doing this at the end of a bull market. On the one hand, this is a time when spectacular profits can be made from taking a trading approach. However, it is also a time of great danger in that once the music stops, so to speak, the profits can vanish almost over night and losses mount. In short, trading successfully at this time of a bull market requires ruthless discipline to cut losses. I suspect from your message that you have learned this the hard way.

Finally, there is the question of mutual funds. If you have bought them with a long-term buy and hold plan, I would not sell them. I think you should have a base portfolio of long-term holdings and trade with only a small part of your funds. There are of course mutual funds with all kinds of investing styles. If you are in speculative ones, get out of them, but if you are in solid basically value investor type funds, stay with them.