How big is the bear this time?

INVESTORS who have not begun taking profits on shares this summer have left it too late. We are in some sort of bear market, with the Footsie down nearly 13 per cent from its July peak of 6,179 and falling 100 or more points every other day.

The real fall in blue-chip shares is even bigger than that - over 15 per cent - for two reasons. The Footsie always exaggerates on the upside because it expels losers and sucks in winners every three months. This year its two biggest members, Glaxo and BT, with a combined weighting of 12 per cent, have sharply outperformed.

You get a more balanced picture of the market if you look at shares such as HSBC, Standard Bank, ICI, Siebe, Smiths Industries, Rio Tinto, BTR and Billiton, all down 40 or 50 per cent from their peaks. Holders of these shares have borne the brunt of the bear's claws.

Even a fall of 13 to 15 per cent suggests some sort of bear market rather than just "a healthy correction". At this stage it is best regarded as a baby bear market, like those of 1990, 1992, 1994 and 1997 - a sudden but limited fall that interrupts a Goldilocks scenario.

If the fall extends to more than 20 per cent it will become a mummy bear market. If it stretches to 30 per cent or 40 per cent, as it did in 1987, it will be a daddy bear market - and a drop of 70 to 80 would make it the granddaddy of all bear markets.

If you don't believe that could happen, remember that it did as recently as 1974. It was a savage bear market that today's teenage fund managers know only as folklore. Edward Heath's Conservative government was thrown out after a dash for growth that dangerously overheated the economy and a clash with the unions that led to the three-day week.

The incoming Labour government of Harold Wilson was overtly anti-business. Chancellor Denis Healey said he would "make the pips squeak" and he did - inflation hit 27 per cent and interest rates 18 per cent. The Footsie plunged nearly 80 per cent from its peak amid talk of "the end of capitalism".

A repeat of that isn't likely. Tony Blair and Gordon Brown are more in the tradition of Margaret Thatcher than Karl Marx, and the Footsie is still well up on the year. It has to fall 400 points before it threatens its January low of 5,069. Inflation looks fairly benign, interest rates may have peaked and shares are not overvalued beside bonds.

But the world outlook, the strength of the pound and the valuation of shares suggest that the biggest pressures are on the downside as we approach the autumn, traditionally a testing time for shares.

The Russian crisis rumbles on and the domino effect in emerging markets has yet to impact fully on Latin America - or on British and American companies. So far our shares and those on Wall Street have seen some benefit from the crises as hot money seeks safe havens.

But stock markets and economies are in a chicken-and-egg relationship, and many emerging markets have already suffered economic damage from stock market falls. It could happen here.

The strong pound has already damaged exports, jobs and profits. But it continues strong, and many companies have yet to count the full cost. Yesterday's CBI survey points a finger in that direction.

Even after the summer shakeout, the valuation of many shares remains worryingly high. The market average p/e multiple is 20 and some prized hi-tech stocks are paying for 20, 30, 50 or even 80 years' earnings. The average yield is 2.7 per cent or 3.7 per cent, depending on what view you take on tax. These statistics are all demanding by historical standards. Wall Street's stats, and those in Europe, are even more frightening.

What can investors do if they haven't done any selling so far this summer? Or if they have taken some profit and are looking for somewhere to switch their money?

The first thing to bear in mind - if that's not too bad a pun - is that the long-term trend is your friend. Stock markets go up in the long run and almost always rise over any five-year period. A fall over a calendar year occurs only once in 10 years, and severe falls like that of 1987 look like no more than a blip 10 years on.

The other comforting thought is that companies don't like to cut their dividends, even in times of recession, and over the long term dividends account for over half the total returns on shares. The outlook still suggests rising dividends over the next two years. So investors can simply grit their teeth, hang on and dream of the next bull market.

But it has proven wise to take some profits this summer, and it will remain so if shares keep on falling. The technique is to take some profits on shares that have risen a long way and are still near their peaks. Try to sell the bounces - days when the index jumps 100 points or so.

Good alternative homes for savings are hard to find, but it does pay in hard times to invest for income to compensate for lack of capital profits. That means building societies, government stocks, convertible stocks and high-yielding shares. After the summer shakeout there are plenty of shares in the Footsie 100 yielding 5 or 6 per cent or more.

But don't be in a rush to sell low-yielding shares simply to buy higher yields. That way you could simply be swapping one problem for another. It's safer to make those kind of decisions three to six months from now.