Taming the Bear Market: Strategies for a Grizzly Bear Scenario
The recent decline in global equities qualifies as a “bear market” and many of the fundamentals align with past periods of extended market decline, such as the collapse of interest rates, widening credit spreads between high yield and investment grade debt and Federal Reserve intervention. Have we reached the bottom of the stock decline? How much further could it go on the downside? Beyond reducing stock exposure are there other strategies to protect our stock investments until this bear market runs its course?
The recent global stock market decline and associated destabilization of credit markets are signs that the long economic expansion may have come to an end and a contraction in economic growth may be upon us. If there is any good news on this front it is that recessions are not long affairs – typically lasting nine months. Traditionally stock prices fall on average between 35-55% over that course of time. It is difficult to estimate if the current market decline (over 25% at one point) has reached its bottom, but if history is any guide, it is unlikely that it has. The coronavirus and its effect on consumers and businesses are at the heart of what is halting economic growth. It appears to our team that we may be months away from getting some sort of control over the virus and these negative effects. Though we may see markets advance in the short term, wise investors should prepare for the possibility of further downside. It is possible that market indexes need to fall another 10% or, in the “grizzly bear” scenario, another 25% from these levels.
Reduced Stock & Sector Management Mitigates Risk
The best way to mitigate loss during bear markets is to reduce stock exposure, which our team has been doing in recent weeks. An additional strategy that we are embracing is to stay invested in companies that can remain profitable during economic contractions and pay dividends. This is an important point that should not be lost on investors. There are many companies that are necessary and may even become more profitable with the COVID-19 virus. Think healthcare, consumer staples and utility stocks. So far these strategies have significantly reduced your portfolio’s downside compared to market indexes. An additional strategy would be to take a portion of your portfolio and sell stock short.
Selling Stock Short
In its simplest form, selling stock short is a strategy of selling stock or an index that we don’t own. When stock indexes fall, the short position rises in value. This can be a great tool when markets decline as it makes a portion of your portfolio gain in value. In bear markets, such as 2008, this strategy added value to overall portfolio returns. In the current environment we would use a market index exchange traded fund (ETF) to do so – a single position in your portfolio that would increase if the market decreased. Of course, we would be careful of when and how much exposure seems prudent. The risk of shorting is that global markets rise and the short position can fall. Our strategy would include the use of a stop loss order to prevent significant downside. If the bear market has further to run on the downside, this might be a good tool to add to your portfolio.
Selling stock short can only be done in a taxable account with a margin feature. Traditionally this strategy cannot be done in an IRA or retirement account – though we are looking at ways that may be implemented.
If this idea appeals to you for the current market or you think it might come in handy in our work in the future, please respond “YES” to this email and we will consider this tool for your portfolio.
We know speaking frankly about a declining market can be a “downer.” However, we think being realistic and proactive is our responsibility.
On a positive note, once this virus, economic contraction and bear market are behind us, we will be at the start of a new bull market. This may be months away but will likely provide great opportunities for stock market investors. The Federal Reserve’s recent rate stimulus along with fiscal stimulus should allow the economy to catapult upward once we contain the virus and companies become better positioned. The first months of a bull market usually coincide with a dramatic advance in stock prices and this one will be no exception – something our team looks forward to!
It is possible – although unlikely – that the recent decline of stocks ends within days and the virus becomes quickly contained. In that more optimistic case we have already lined up a list of great quality companies to purchase for you and are ready to do so.
All of us on the team pray for those affected by the virus and that the world brings this situation under control in the near future. In the meantime, we will continue to manage the risk of your investments and hope you take care during this abnormal time.
If you would like to discuss your portfolio or have experienced change in your finances please contact us.
If you know of a family member or friend who might benefit from our risk management strategies please let us know and we would be happy to have a discovery call or meeting with them.
Your Team at Main Street Research