If a bear market has started, what are you going to do? Wait for the media to tell you it's down 20% before they declare it’s a bear? That's a little late.
The first thing an investor needs to do is acknowledge that a bear may be starting. Indicators of a bear market can include high market valuations, low earnings growth, rising interest rates, and geopolitical events among others. Seems we have all those right now.
You also need to decide what kind of investor you are. What were you before the bear started? What are you now? Below are various strategies; some will work better than others, depending on your investment style and personality.
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1) Go to 100% Cash. This is a drastic move, and one that may be done out of fear and panic.
Benefit: You can let the market fall and not have a care in the world.
Danger: When do you get back in? If fear and panic drove you out, seeing the market rally may entice you back in at the wrong time. Bear markets have "sucker rallies" that tend to fool people into thinking the decline is over.
Solution: Make your decisions based on fundamentals, and decide what fundamentals will bring you back in.
2) Go Partially into Cash. Selling off the most overvalued securities in a portfolio is a reasonable strategy. This requires analysis and a strategy.
Benefit: Having cash available to buy when stocks are cheaper, and protecting the portfolio during the decline.
Danger: Bear markets may last a long time (years), and investors with cash can get antsy to get back in. Getting back in too soon can expose an investor to the rest of the bear.
3) Use Portfolio Hedges. Some securities that can give a portfolio some protection or a hedge are designed to move in the opposite direction of the major indices. These include index options, futures, inversely correlated ETFs, and shorting. Depending on your level of skill, knowledge and risk tolerance, some may be appropriate and some might not.
Benefit: If done properly, these strategies can offset some or all of the losses of a portfolio.
Danger: Since these types of securities move in the opposite direction of the market, the losses can be substantial if the market rallies. Also, shorting involves unlimited risks. (At Cornerstone, we never short, but do use other tools/strategies to hedge portfolios.)
4) Stop Loss Orders.To protect a portfolio on the downside, Stop Loss orders may be the answer. It is an order placed below the current price. If the stock falls to that price, it is sold automatically.
Benefit: You can keep your portfolio until the Stops are hit, and you can raise the Stops as the price of the securities go up.
Danger: Stop Loss orders are no guarantee that your stock will be sold at that price. Once a stock price hits the stop, it becomes a market order and is traded at the market. If the stock drops below the Stop price, you may get the lower price.
5) Employ a Tactical Strategy. This allows an investor to have exposure to various sectors or securities for the time period that the sector or security fits the parameters of the Tactical Strategy. A Tactical Strategy may allow for the portfolio to be fully invested and may have a strategy that would go fully into cash, based on market conditions.
Benefit: Gives the investor the ability to be all in, partially in or all out of the market. It can benefit from the rallies in a bear market while having a strategy to get out when things start back down.
Danger: The strategy has to be able to actually go all cash. The strategy should not be one that stays fully invested but shifts among asset classes. No tactical strategy guarantees against losses.
6) Actively Trade. This strategy is for very, very few investors. By actively trade, I do not mean day trade. I mean watching a particular security and trading it from point A to point B and not caring if it goes further up. Most importantly, a trader has to be willing to take losses if it doesn't work out right.
Benefit: Done right, it can add percentages of return to a portfolio's performance.
Danger: You can lose money very easily. Trades can become long-term holds if they decline and you do not have the discipline to take the loss. Also, investors can get greedy and start to get in over their heads by trading too much too often. That is when problems can happen and losses pile up quickly.
7) Contrarian. Watching for the securities that have gone down the most first can be beneficial if they also recover first. When the market is down 10%, a sector that is down 50% might be a place to start looking for contrarian plays.
Benefit: With discipline, it can get an investor into the securities everyone else is selling, at good prices.
Danger: It takes a strong stomach to go against the grain. Be prepared to see what you buy go lower, so focusing on the long term is essential.
8) Stay Put – Do Nothing.This is the advice given to many investors as they watch their portfolios dwindle. While it is good advice during a bull market, it may not be the best strategy during a bear. Doing nothing means you are willing to accept all the risk of the market. We don't see how that is a good strategy.
Benefit: You don’t have to do anything, and when the market eventually recovers, you are fully invested.
Danger: Markets can take years to fully recover. According to Dow Jones data, the Dow Jones didn't stay above its peak in 1966 until 1982. Nikkei data shows that the current market in Japan is still down more than 50% from its peak in 1989, 27 years ago!
A bear market is nothing to play with. But with the right strategies, it also doesn't have to be feared. Any of the first seven strategies or a combination of these strategies may help an investor weather to storm and maybe even profit from a bear market.
John Riley, registered Research Analyst and the Chief Investment Strategist at CIS, has been defending his clients from the surprises Wall Street misses since 1999.
Disclosure: Third-party posts do not reflect the views of Cantella & Co Inc. or Cornerstone Investment Services, LLC. Any links to third party sites are believed to be reliable but have not been independently reviewed by Cantella & Co. Inc or Cornerstone Investment Services, LLC. Securities offered through Cantella & Co., Inc., Member FINRA/SIPC. Advisory Services offered through Cornerstone Investment Services, LLC's RIA. Please refer to my website for states in which I am registered.
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