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Beware the market bears emerging from their lairs

It was bound to happen. After months of defying gravity, including a first quarter that ranked among the best since the Internet bubble years, global equities are showing distinct signs of altitude sickness.

The market bears came out of their lairs early last week, only to retreat when stocks suddenly reversed course in mid-week. After five down days, the Dow swung back to its biggest gain in nearly a month. But by Friday, it was plain that not even stronger than expected U.S. corporate profits could lift the gloom spread by China's economic slowdown, fresh worries about the U.S. recovery and the euro-zone's continuing debt woes. The S&P 500 fell for the second week in a row. Europe's leading index marked its fourth consecutive losing week and Canadian stocks, with their heavy resource weighting, fell for the seventh week.

Volatile markets may well change directions frequently in coming weeks, but the portents don't look good. For one thing, investors have been fleeing global equity funds. More than $9.2-billion (U.S.) departed in the latest week, the highest redemptions so far this year, according to EPFR Global, which tracks fund flows around the world. It probably doesn't help when a senior European politician tells people the euro is doomed and they should get their money out, as former Italian finance minister Giulio Tremonti is quoted as telling an Italian newspaper. And then we had a stark warning from Bank of America's Merrill Lynch folks, telling investors worldwide to shed risk, after a surge in key components of its global financial stress index. It was the first such red flag from the index since last July, just before stocks swooned.

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Luckily for the gambling set, Jim Cramer, CNBC's extremely loud but influential stock tout, has other ideas about the market: "2012 is no longer about global economic crisis, it's about buying stock in the companies you love," he declared with his usual ebullience.

One investment pro who definitely wasn't listening to Mr. Cramer is veteran U.S. financial adviser David Edwards. Even though he might agree with the sentiment, Mr. Edwards tells investors to steer well clear of anyone urging them to do more trading, especially in volatile markets.

The first advice he gives new clients is to ignore TV's squawking heads, especially the high-profile Mr. Cramer, whom he calls smart, talented and effectively "leading average Americans off a cliff. I call him the Pied Piper of investment advisers. His thesis is that you can do your job, take care of your family and day-trade your 401K [U.S. retirement plan]" Maybe two people out of a thousand "can achieve that skill after years of practice," says Mr. Edwards, who penned an investment report last November titled Why Watching CNBC Won't Make You Rich. "The rest should stick to index funds."

As for current conditions, the market is going through nothing more than an overdue correction, insists the president of New York-based Heron Financial Group, which handles investments for wealthy families. At the end of December, he forecast that the S&P 500 would gain 12 per cent in 2012. But by April 2, the benchmark U.S. index was already up 13 per cent for the year – and 30 per cent since last autumn.

"That falls in the category too far too fast. We covered three to four years worth of return in six months. It would be normal to have a bit of a pullback. And if one person starts taking a profit, everybody takes profits and the market can fall 3, 4 per cent in a week. I don't care in the slightest about that." Indeed, the S&P is now up about 9 per cent for the year.

The decline does not mark the beginning of a return to the harsh market landscape of recent years, he says emphatically, citing still decent corporate earnings, modest economic growth, a dramatic reduction in leveraged investing and greater caution.

"Bear markets seem to come when there's an excess of leverage and a deficit of risk management," Mr. Edwards notes. But the days of excess are over, at least for now. And "everybody knows that those value-at-risk models [used to gauge the dangers of particular strategies]aren't worth a dime. So they're employing human judgment to keep track of things."

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Plenty of stocks remain reasonably priced by typical valuation measures – and many are still bargains – he says. Yet most of the investors who stampeded for the exits during the market meltdown of 2008 and early 2009 have yet to return. "Most of the time, buying stocks is a winning proposition. But what I suspect is that most people are so frightened by what they've learned in the last 10 years that they're never going to touch stocks ever again."

Mr. Edwards has been talking to prospective clients who converted everything to cash at the bottom of market and intend to stay there, despite the negative returns. One person proudly told him he has $5-million spread across 20 banks, to ensure his stash is covered by federal deposit insurance. If the banking system is in that much trouble, Mr. Edwards responded, " there isn't enough insurance in the world to cover American losses. At that point, our asset allocation strategy would be canned goods."

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More

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