By: DanielXX Stockpicking in a bear market can be a hazardous business, because going long in deflationary conditions is by definition an attempt to pick a bottom (whether intermediate bottom or long-term bottom) on the stock price. It is easy to be bloodied by the falling knife, especially if one attempts to catch it naked (eg. contra, no ability to hold). One could thus simply choose to avoid risk and not hold stocks altogether, which is the reason why we have a bear market at all --- risk aversion leads to lower volumes and the stock prices drop by gravity due to lack of support. But yet, if we define risk as the potential loss on investment over say 3-5 years, rather than the standard textbook definition of price volatility which I have always maintained is more appropriate for short-term leveraged players than for long-term investors (see my article on risk), then buying stocks during a bear market could be a low-risk proposition indeed (because you are buying at a lower base and hence risk of losing is lessened over the long term), assuming that the bear cycle reverses in several years. I feel that a good model for picking stocks in a bear market would be to examine the cash bailout potential of a stock over the medium to long term. I build my ideas based on the "cash bailout" concept as espoused by Martin Whitman in his book "The Aggressive Conservative Investor", which was written in the late 1970s when stagflation gripped the US. The general idea is to view a stock with regard to its potential to allow the holder to eventually bail out; under this umbrella of "cash bailouts", selling in the open market for capital gains is but one of the bailout exits; other potential exits include dividends and privatisation. This way of viewing a stock is especially useful in a bear market where most small-cap stocks may be thinly-traded and selling out of them may be difficult. Yet, illiquid small-caps often offer the best potential gains. I adopt a two-horizon approach to picking these stocks in a bear market. Read more...