"Remember that bear markets are part of the normal cycle of investing, and they can create opportunities for those who are prepared to take advantage of them." - John Paulson
A bear market is traditionally defined as a period of negative returns in the broader market where prices fall 20 per cent or more from recent highs. During this type of market, most stocks see their share prices fall at least that far. There are several strategies that are used when investors believe that this market is about to occur or is occurring, which depend on the investor's risk tolerance, investment time horizon and objectives.
But bear markets aren’t for panicking. In fact, there is a lot of opportunity in bear markets. As the famous investor Peter Lynch once said,
“You get recessions, you have stock market declines. If you don’t understand what's going to happen, then you’re not ready, you won’t do well in the markets.”- Famous investor Peter Lynch
So, if you’re unsure of what is a bull vs. bear market, this article will help clear up the difference.
One of the safest strategies and the most extreme is to sell all of your investments and either hold cash or invest the proceeds into much more stable financial instruments, such as short-term government bonds. By doing this, an investor can reduce his or her exposure to the stock market and minimize the effects of a bear market. That said, most, if not all investors, have no ability to time the market with accuracy. Selling everything, also known as capitulation, can cause an investor to miss the rebound and lose out on the upside.
For investors looking to maintain positions in the stock market, a defensive strategy is usually taken. This type of strategy involves investing in larger companies with strong balance sheets and a long operational history, which are considered to be defensive stocks. The reason for this is that these larger more stable companies tend to be less affected by an overall downturn in the economy or stock market, making their share prices less susceptible to a larger fall. With strong financial positions, including a large cash position to meet ongoing operational expenses, these companies are more likely to survive downturns. These also include companies that service the needs of businesses and consumers, such as food businesses (people still eat even when the economy is in a downturn).
On the other hand, it is the riskier companies, such as small growth companies, that are typically avoided because they are less likely to have the financial security that is required to survive downturns.
These are just two of the more common strategies and there is a wide range of other strategies tailored to a bear market. The most important thing is to understand that a bear market is a very difficult one for long investors because most stocks fall over the period, and most strategies can only limit the amount of downside exposure, not eliminate it.
Finally, that one strategy to be used in all markets
A common complaint of most investors is that by the time the bull market or bear market is identified, the damage to the portfolio is done and the risk appears to be too high. How can one address this issue? After all, it is a very practical issue faced by investors and traders alike. The answer could lie in a more allocation-based approach to stock markets. Here is how it will work.
Your starting point is normally your financial plan where you make allocations to equity, debt, gold, liquid assets, etc. Normally, when you define the range you also define the outliers of the range. What exactly is an outlier? If you allocate 60% to equities, then you can set a trigger that 70% will be an outlier. When equity exposure touches 70% you automatically reallocate the profits to debt so that the original allocation mix is maintained. This is a passive approach but can work beautifully for handling the vagaries of bulls and bears.
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