Scars of 2008 Still Fresh?

Dave Carpenter of the AP reports, Market may be up, but the scars of 2008 are fresh:

Cheryl and Jim Friedman, retirees in St. Louis, had two-thirds of their retirement money in the stock market in 2008. When the financial crisis struck that fall and stocks lurched up and down with nauseating speed, Cheryl, a former accountant, pulled the money out.

Fearing that the next crisis was always around the corner, they have kept most of the money out. It's parked in a money-market account earning a meager 0.1 percent per year. The Friedmans watched in agony as stock prices doubled over the past three years.

"I have a whole lot of money sitting on the sidelines, because I'm afraid," she says. "The little guy is thinking, 'Well, things are good again now, I'll get back in.' And that's when they pull the rug out from under you."

Three years ago Friday, the Dow Jones industrial average closed at 6,547, its low during the Great Recession. Retirement accounts across the country had been devastated since October 2007, when the Dow hit a record of 14,164.

Last week, the Dow closed above 13,000, although it has fallen back slightly. It has been one of the greatest three-year runs in the history of the stock market, exceeded only by the dot-com stock craze of the late 1990s and the recovery from the Depression.

Some people gritted their teeth through the steep losses and poured more money into stocks while the market was still in free fall. That daring paid off in the returns of a lifetime.

"I felt that either the world's going to end or it's the smartest time ever to invest," recalls Harvey Bookman, 60, of Brooklyn, N.Y., who has made up his initial market losses many times over by buying when stock prices were low.

Bookman bought shares of Avis stock for 41 cents apiece on March 4, 2009, five days before the bottom. He sold them in September 2009 for $11.92 apiece. Total profit, minus commission: $46,026.

For many more, however, even a doubling of the market has not been enough to get them back in. The scars of the 2008 crash, when the Dow lurched up or down by 500 points or more in a day and people asked aloud whether the economy itself would survive, are that deep.

Since the March 2009 low, there have been only two months in which individual investors put more money into stock mutual funds than they took out, according to EPFR Global, which tracks funds.

The fuel for the market's ride higher since 2009 has come from big institutional investors instead.

For small investors, there have been more than enough reasons to sit out. After the 2008 crash, there was the "flash crash" of May 6, 2010, when a large trade overwhelmed computer serves and the Dow plunged to a loss of almost 1,000 points in minutes.

In just the past year, the European financial crisis, a downgrade of the United States credit rating, fear of a default by the U.S. government, high gas prices and supply disruptions from the Japanese tsunami have all whipsawed the stock market.

"It doesn't feel like we've doubled over the last three years," says Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "The S&P's gains were masked by all the turbulence. That's probably why so many individual investors are sitting it out."

Joe Kelly, a financial planner in Bordentown, N.J., said one of his clients, an office manager in her 50s, yanked all $200,000 of her savings out of stocks and into cash one night in January 2009, against his advice.

Temporary peace of mind turned to angst as she missed a historic rally.

"She's crying," Kelly says. "She's lost so much money."

People who had the intestinal fortitude to sit tight during the crash have reaped three years of rewards. 401(k) account holdings have mostly recovered. And contributions at every paycheck during the market bottom bought shares of stock at bargain prices.

It's been harder for retirees who don't have big savings and have less time to recover from severe downturns.

"People in retirement are having a heck of a time dealing with this volatility," says Paul Jarvis, a financial planner in Fargo, N.D., who has spent extra time calming the fears of older clients. "They're trying to psychologically get a grip on how it affects them."

They also have few appealing alternatives to stocks if they want to earn decent income on their savings. The Federal Reserve has kept interest rates low since 2008, first by cutting short-term rates and then by buying Treasury bonds, which have reduced long-term rates.

Those moves left investors a choice of taking more risk with their money in the stock market or settling for near-zero returns on money-market funds and bank savings accounts, and not much better on certificates of deposit.

Those who have the stomach to stay in stocks may have reaped rewards, but they will never forget the ride.

Jay Sachs of New York recalls thinking about putting his savings under a mattress when the Dow plunged 777 points on one day in September 2008. By the following March, with daily declines continuing, he was still "scared out of my mind."

But Sachs, a retired computer consultant, soon tiptoed back into the market, buying dividend-paying blue chips and some mutual funds three years ago. Today his portfolio is well above where it was before the crisis began.

But his optimism is muted because of what he endured in 2008.

"The fact that there's still some fear out there is probably a good thing," he says. "Because when everyone is euphoric, you'd better start trimming your sails."

Bookman of Brooklyn, a retired software executive, is an investing enthusiast who made more than 1,700 trades through his Scottrade account last year. He prides himself on keeping emotion out of his investing.

That strategy was severely tested when he lost 70 percent of his holdings in eight months during the crisis. But he kept going, remembering the advice of Warren Buffett, the billionaire investor: Be fearful when others are greedy and greedy when others are fearful.

"I just kept buying because I had waited for this time my whole life," he says. "I had heard about the Depression when anybody who had bought at the bottom made a fortune."

Even investors who put their faith, and their money, in the market during its darkest days have muted expectations for stocks in the near future. Expecting a pullback in stocks, Bookman has sold 30 percent of his holdings in the last two months.

"I just think that people right now are too complacent," he says. "I hear about all the problems with Europe and the economy, and a lot of people are out of work, so I don't think things are so good. The market is way up, but the world hasn't changed so much."

Financial experts say the experience of surviving 2008 may embolden investors the next time there's a market shock.

"When we have these downdrafts, they're a good reminder of volatility and a good opportunity to load up on stocks when they're cheap," says James Angel, associate professor of finance at Georgetown University's McDonough School of Business.

Small investors like Doug Heuring, 40, of Cape Girardeau, Mo., vow to be ready for the next crisis. Heuring, a medical technologist, snatched up some biotechnology stocks "when the market was on sale."

His portfolio is 30 percent or more above where it stood when the crisis hit. He knows he could have done even better had he been bolder. But at least he didn't flinch when the market tanked.

"You've got to stay the course," he says. "A lot of people panic when their stocks hit lows, but if they're good companies, they will come back."

That is not so easy for Cheryl Friedman, the St. Louis retiree. She sits in her office and watches market chatter on CNBC all day, waiting for the appropriate time to get back into the market. But the timing never seems right. Not when the crisis was fresh, and not now, when stocks are up more than 20 percent since early October.

"It's very difficult to know what to do," says Friedman, 63. "I should have just sat back and waited. But when you're at this point in life and there's no way to replace your assets, you can't afford the risk."

I feel for a lot of people who are sitting on the sidelines and don't want anything to do with this wolf market dominated by large hedge funds, big bank prop trading desks, high frequency trading scam artists and naked short sellers.

And while some made money buying the dips on markets or specific stocks, most have lost their shirt. This is a crazy market. I know because I look at it all day long and have made and lost money in my adventures in swing trading high-beta stocks.

What are the hardest and most important lessons I've learned in trading? Knowing when to jump in and more importantly knowing when to take your loss and knowing when to sit tight. What else? The macro environment matters and you need to understand liquidity and how the coordinated efforts of central banks are influencing the risk appetite of elite hedge funds, big banks and other institutions.

The best of the best know when to take risk and more importantly, they know how to manage their risk when they're wrong. Go back to read my last comment on Bridgewater's Ray Dalio and listen carefully to that interview. Ray is more optimistic nowadays, and I can vouch for that just by glancing at Bridgewater's Q4 2011 institutional holdings.

I go over the portfolios of elite funds to see what they're buying and selling. I use this information for ideas and to gauge their risk appetite but never follow them blindly. First, the data is lagged, so by the time it is public, the moves in the stocks have already taken place. For example, Bridgewater bought a stake in International Paper (IP) in Q4 2011 when the shares pulled back, but the big move has already been made, so I'm not jumping on that trade.

What do I watch for? I watch for elite funds adding big positions to stocks that fell during the quarter, as well as when they're adding to stocks that are being heavily shorted. That is when I put them up on my radar, do my due diligence looking at fundamentals and technicals, track them closely and wait for the right time to pull the trigger (like this past Tuesday when everyone was scared to death of the rally running on PSI fumes).

This sounds easy but it isn't and most people, including yours truly, can get burned very easily. For example, I've made and mostly lost money playing solar stocks, among the most volatile stocks in the market. It was a fun ride, learned a lot by trading these volatile stocks, but now I am getting more serious about making money wherever opportunities present themselves, not just in solars which have left me with bad sunburns (still like trade them but they're heavily manipulated).

My fixation on solars came at an opportunity cost. Back in Q3 2011, when the shit hit the fan, I noticed Citadel added significant positions in Lennar (LEN) and Paulson bought Beazer Homes (BZH). Both stocks have been on a tear in the last six months. In fact, homebuilders and financials move in tandem (makes sense since banks are exposed to housing), and both sectors have been on fire since early October (homebuilders a lot more, click on charts below):

Interestingly, Paulson cut his huge holdings of banks at the worst possible time, right before they took off. He's probably kicking himself for getting out of banks in Q3 2011, but just goes to show that nobody, not even elite hedge fund managers, know where these crazy markets are heading with perfect certitude. It's a lot easier making these calls in hindsight but when you're under the gun, running institutional money, you need to cut risk, especially when you're down 50% like Paulson was in 2011.

I can share a lot of stock ideas with you as I am obsessed with tracking the institutional portfolios of elite hedge funds and long-only funds. This is how I become a better trader/ investor, by piggybacking off the work of elite funds, never following them blindly, but understanding where and when they take risk.

Admittedly, I love the stock market, and can look at charts and institutional holdings all day long. Every week I learn something new. For example, noticed Sprint Nextel (S) popped this week and lo and behold, Ontario Teachers Pension Plan is a major holder and so is Greenlight Capital, a well known hedge fund I track. So is Dodge & Cox, a well known long-only shop I track. Am I buying shares of Sprint Nextel? No but it is on my radar as the stock seems to be breaking out from these levels.

And let me show you my chart of the decade. It is a comparison of Intuitive Surgical (ISRG) vs. Apple (AAPL) and the SP&P 500 since 2000 (click on image to enlarge):

You can see that over the long-term, Intuitive Surgical has returned more than Apple, a whopping +2200% (Apple close to 2000% and has been gaining on them in last 3 years). So much for all the hype about the post-PC revolution. More sobering and depressing is that the S&P 500 hasn't done anything over the same period (good old boring bonds were actually a much better investment). If you predicted any of this back in 2000, they'd think you're crazy!

That's why so many retail investors feel betrayed and think the stock market is rigged. And they're right, the stock market is rigged. It's become a big casino where elite hedge funds and top trading desks at big banks make money and the rest of the people often get burned. This is why I am firmly against the trend towards defined-contribution plans, placing the retirement onus entirely on individuals, as it will only accelerate pension poverty.

Below, a Yahoo Daily Ticker interview with Lance Roberts, CEO of Streettalk Advisors, who discusses with Henry Blodget why the "game is rigged". Listen carefully to his comments and ask yourself this: how are investors going to compete in an environment where even the best hedge funds can get burned?

I agree with Roberts, you need to play the long-term game but add timing and trends (and even take concentrated risks at times) to make money in these markets. Unless of course you know what the next Intuitive Surgical is going to be (better chance of winning the lottery!).