I believe the long-awaited bear market started in October. That’s consistent with my forecast for a recession in early 2019.
Before a recession begins, stock prices turn down. And there is always a bear market during a recession. On average, the S&P 500 Index dropped 37% in the last 10 recessions.
That’s a grim outlook. But you should not sell all your stocks and move to cash. That could be the worst thing to do.
Moving to cash requires two decisions. The first is obvious. It’s selling your stocks.
The second decision is hiding in the future. It’s the question of when you get back in. Many investors forget about this one.
Bear Markets Almost Always End Without Warning
When I managed money, I saw many individuals who sold everything in early 2009.
That was just before the bottom. It was also after they had substantial losses. More than a year later, even two years later, some were still in cash.
That’s one problem with selling everything. You miss the recovery.
When the bottom comes, it’s sudden. The S&P 500 gained over 26% in the month after bottoming in March 2009. Three months after the bottom, the index was up more than 41%.
That is typical. Bear markets almost always end without warning. Then rapid gains at the start of a bull market reduce a large part of the bear market losses.
If you sell everything, you miss those gains. But it’s difficult to believe the recovery is real. That means many investors refuse to buy stocks as the quickest gains are unfolding.
Investors can never recover gains they miss out on. So, it is always important to have some exposure to the stock market. Even in bear markets.
Another Reason to Maintain Exposure
History also shows not every stock will decline in a bear market. Almost all stocks will be down, but not all of them.
The chart below shows the number of stocks in the S&P 500 that were above their 50-day moving average (MA) as the stock market bottomed in 2009.
The 50-day MA is one way to define whether a stock is in an uptrend.
Even at the lowest point in the bear market, more than 6% of the stocks in the index were in uptrends. Most of the time, at least 40% of the stocks were in uptrends.
That chart shows owning the right stocks can deliver gains even in a bear market.
A Diversified Bear Market Portfolio
Investors won’t enjoy gains every day. But they won’t have any gains if they move completely to cash.
Now, even though you should not sell all your stocks, you could consider selling some. Maybe sell some stocks that show a loss to reduce your tax bill.
Holding more cash than usual is also a good idea. If you usually keep three months of living expenses in reserves, for example, now could be an ideal time to boost that to six months.
Now is also the time to plan for the end of the bear market. Because the end of the bear market is inevitable.
Decide when you want to become more aggressive. Know when you will increase your positions so you maximize the rapid gains that will come after the bear market ends.
Finally, put options are a way to benefit from price declines.
Puts give you the right to sell a stock or exchange-traded fund until the option expires. They increase in value when prices fall.
A small position in puts could offset some of the losses in high-quality stocks that you continue to own.
Win in Any Market
So, yes, we’re in a bear market, and it’s time to build a diversified bear market portfolio. That includes a combination of stocks, cash and put options.
Continue holding the kind of stocks that will recover quickly, and buy more high-quality stocks as prices decline. At the same time, increase cash and add puts to your portfolio.
These actions will allow you to win in the bad times of the bear market and the good times that will follow the end of the bear market.
Michael Carr, CMT, CFTe
Editor, Peak Velocity Trader