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Vitaliy Katsenelson is Director of Research at Investment Management Associates in Denver, CO.  See our interview with him last week. 

I wrote an article in February 2007 in the Rocky Mountain News called - "You are not as smart as you think" (see the second article on page two), which was written to address the overconfidence we get in bull markets.  Today, I've slightly rewritten the same article to address the underconfidence of bear markets. 

Lately I've been getting this nagging feeling that everything I touch turns to dirt. Every time I buy a stock that is already down a lot, the one that my analysis leads me to believe is cheaper than dirt, it declines more.  Did I completely lose my ability to value stocks?  Did I start ignoring Will Rogers' advice? Buy stocks that go up, and if they don't go up, don't buy them.

No, I didn't get much dumber, and my stock picking skills haven't diminished that much over the past year. I was simply a willing participant in the latest (cyclical) bear market. Bear markets make you feel dumber than you are, the same way a bull markets make you feel smarter than you are. Feeling dumb makes you do the opposite of what you should be doing. Fear and pain - yes, continued losses cause a lot of pain - are dangerous things because they can make you (and me) panic, lose confidence and do the opposite of what we should be doing.  

To alleviate pain we sell, we react, we default to the only asset that made us money (so far) in the bear market – cash!  Cash is only a king when other assets are princes.  When you cannot find a stock with a long-term (a key word) superior risk reward profile, then cash is King (with capital “K”).  However, during a cyclical bear market, cash is slowly demoted to a prince as great companies are thrown out the window with the junk ones. 

You have to actively make yourself aware of the eight-letter word T-O-M-O-R-R-O-W!  Yes, tomorrow.  Think of the lyrics from Annie:

Of course, we don’t know if tomorrow is tomorrow or years from now.  But investing is a marathon, not a sprint, and do not let the bear market turn you into a sprinter. 

First of all, remind yourself that you are not as dumb as your portfolio makes you feel.  You have bought a stock (once or twice) that made you money.  This is what I do.  I pull out a chart of a stock on which I made a boatload of money or one I sold (for the right reasons) before it declined.   I do this with pleasure, trying to relive my "smart days".

We all have these stocks, the ones we nailed. We tend to forget about them during the bear market phase. But I suggest you remember them now, when you feel lonely and miserable, so you'll have more of these names to remember in the future as cash will not bring the pleasure of victory in the long-run.  The cyclical bull market is still there; it is just hiding under the ugly sentiment of the cyclical bear market. Believe me, it will show its happy face.  It is just a matter of time.

In a bear market, it is easy to forget about buying. Selling is a much easier decision to make. Every time you buy a stock you look dumb because it usually goes down afterward. I recently bought a couple of incredibly cheap stocks and, of course, they declined.  I don’t feel smart about these buys right now. However, awhile back I analyzed these companies, figured out what they are worth, determined an appropriate margin of safety and got my buy prices.  Stocks declined, fundamentals have not changed, so I bought these stocks.

You cannot worry about marking the "bottom" in every buy. My objective is not to buy at the "bottom" and sell at the "top." No, my objective is to buy a great company when it is cheap and to sell it when it is fairly valued! I suggest you do the same.  Will Roger’s advice is great, but unfortunately I am yet to meet a human being who has figured out how to apply it in real life.  No, you are not as dumb as bear markets make you feel.  

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