By Chuck DiFalco

Have you ever opened a box of food you bought from the grocery store, only to notice that there is as a lot of empty space? "Contents may have settled during shipping." Yeah, right. Well then why did your same size box used to weigh more? Why didn't the package price drop because there is less of the product inside?

The year 2011 has already brought a cyclical bear market in the United States. The stock market declined this year more than 20%. For you technical purists out there, the difference between high and low exceeded the bear market benchmark on a closing basis, not just intra-day. The Wilshire 5000 index closed on April 29, 2011 at 14,495.43, and closed on August 3 at 11,459.36. The closing price, by the way, is the most important price of the day, when many participants must either fish or cut bait. Thus the US stock market went down 20.9% on a daily closing basis over that three month period this year.

I can already virtually hear the objections. "The Dow only dropped 16.8%!" "The S&P500 went down less than 20% on a closing basis!" "B-b-but the NASDAQ..." Throw me a bone here. The Dow Jones Industrials, besides not being very industrial anymore, consist of 30 US megacap stocks. The Dow was a simple guide before the advent of computers to calculate broader indexes. The NASDAQ index contains many technology stocks. That’s a handy index for one sector. These indexes, however, are too narrow to capture the entire US market.

The S&P500 represents about 75% of the market capitalization of all US publicly traded companies. I look at it often. It's convenient so many ways -- easy to see on-the-go, easy to find analysis about, easy to find out earnings data, and easy to calculate changes in my head. However, even Standard and Poor’s says that their most popular index best represents large United States corporations. I admire their dedication to accuracy. But three quarters of the market means leaving out thousands of mid and small capitalization companies. As far as indexes go, why not have the whole enchilada? Why would I not want to use the broadest measure? I don't know anyone at Wilshire, nor have I ever worked for the company. I just find useful their stock market index.

After this necessary digression, I hope I don’t hear “It depends on which index you look at.” Is that because you’re more comfortable with another index? If so, I submit that is biased thinking. While “falling in love with an investment” is more famous, “comfort zone” bias means staying in a train of thought because it’s familiar, such as a market index seen and heard on television, on the internet, and by water coolers every day. Political bias, and the bias of past investment success, can also lead to poor returns. Stock markets generally are not zero sum games over long timeframes. Many players, though, eagerly will take lunch money away from subjective thinkers.

For those who think a 20% benchmark is too arbitrary to be useful--why not define down 25% as a bear market?--I disagree. Bear markets as popularly defined are uncommon. They are useful gut checks for an investor. Was I correctly identifying market signals telling the smart money that risk was increasing? What did I do right, and what did I do wrong during this bear market? Was I trimming riskier investments near the top? Was I raising my cash allocation to prepare for the upcoming cyclical bull market? Did I have a grocery list of investments to deploy that cash when there was a sale? Did I learn something to better prepare for the next cyclical bear market? Financial education is as much about knowing oneself as it is about understanding markets.

For my own part, what I did right was to go early on “sell in May and go away.” In April, for example, I sold the real estate mutual fund in my 401k. I didn’t like how the high expense fund was performing, and I saw an opportunity to get out at a good price. In early August and early October, I saw panic in the charts. I took advantage. For example, US utilities stocks were plummeting for no fundamental reason. I gobbled up that high yielding investment. What I did wrong was to short treasuries. I thought there was no way the US 10 year Treasury yield would go below the 2008 low. I was wrong. I get that shorting Treasuries could be the trade of the decade. But it's not working right now. I got out of that position with modest losses.

Ding ding! Ok, I have (virtually) rung the bear market bell. Since news of the bear market is behind us, and portfolio reviews have been done, it’s time to let the past go and to think ahead. It's a bit late to sell now, after a recent 20% drop. Also, another round of quantitative easing by central banks could make mincemeat out of people who short. So will the bear market continue by breaking below the October low? It certainly seems like a small fry version of the Great Recession. If the cyclical low is dead ahead, do you now have enough cash allocation available to go long? If the markets go up from here, are you comfortable with your current portfolio allocation to money market funds?

Why might the cyclical bear market low occur in the upcoming months like happened in March 2009? European and US governments have high profile opportunities to do monumentally stupid things between this Thanksgiving week and just after next year’s US elections. Upon hearing the uncompromising sides of the Washington budget debate and the cacophony amongst European political leaders, nobody can forecast what a few dithering turkeys on either side of the Atlantic will do. The half-baked policy agreements we’ve seen so far only serve to kick the can down the road. Never underestimate the power of incompetence. Just remember that bulls make money, bears make money, but pigs get slaughtered. Think of incrementally but opportunistically changing your asset allocation as portion control.

Copyright ©2011 Chuck DiFalco. All rights reserved. Living in League City, Texas, Chuck DiFalco is a software engineer by day, and an unconventional thinker and writer by night. He can be reached at This e-mail address is being protected from spambots. You need JavaScript enabled to view it .