When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.
New ideas on bear market investing
When stock prices keep going down, it’s a bear market. That means different investing strategies are required to protect (instead of grow) your portfolio.
Big ideas
- When a bear market happens, investing strategies that worked well in a bull market are often less effective or just stop working. It’s time to switch from trying to grow your capital to trying to preserve it.
- The sector rotation model shows how investors rotate between sectors in accordance with the business cycle and bull and bear markets.
- The relative strength of stocks in your preferred sectors relative to an industry benchmark can help you decide which companies to own.
Bear market investing strategies (don’t be bullish)
How to make money in a bear market tends to be different to how to make money in a bull market. The archetypal example of what stops working in a bear market is buying the dip. When it's a bull market, stocks overall are rising, so it’s not hard to find a stock in an uptrend. Stocks rarely go up in a straight line, so whenever there is a pullback from the main trend, investors can buy the stock on the dip in anticipation of the next rally. The trouble with a bear market can be seen in the below chart of the S&P 500 index (SPX). The rallies fade too quickly and dips keep going too long.
Bear market (2000-2003)
Source: TradingView. Past performance doesn’t guarantee future results.It is possible to throw this strategy on its head. That’s called ‘selling the rip’. You find a stock in a downtrend, which should be the majority of them. When there is a bounce, you sell the stock short in anticipation of the next drop to new lows. But this is very risky and really isn’t appropriate for most investors.
How to invest in a bear market
As bad as things can feel in a bear market when your investments aren't worth as much as they were, especially if the economy is poor too, every bear market in history has been followed by a bull market. Investing in a bearish market means managing the present while also looking forward.
Quote
"Bull markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria."
Sir John is simply saying the next bull market is born in the bear market. So a bear market is not a time to stop investing because you want to be there ready to capitalise on the next bull market.
When investing during a bear market, it's a good idea to switch from a strategy of capital appreciation to a strategy of capital preservation.
Let’s remind ourselves of uncle Warren’s two most important rules of investing.
When investing during a bear market, it's a good idea to switch from a strategy of capital appreciation to a strategy of capital preservation.
Let’s remind ourselves of uncle Warren’s two most important rules of investing.
Quote
"Rule number 1: Never lose money.
Rule number 2: Never forget rule number 1."
Rule number 2: Never forget rule number 1."
What smart investors do in bear markets
During a bear market, you want to concentrate your efforts on making sure you keep as much of your capital as possible. That way you stand to benefit the most from the next bull market by having more to invest with.
There are different bear market strategies, but they should all amount to reducing risk in your stock portfolio. You can reduce risk by selling stocks, however, studies have shown that market timing is very difficult. Most of us will likely sell out of our stocks at just the wrong time, probably based on emotions rather than a solid rationale. And not only that, it will probably be too late to buy back into the next bull market.
The other way you can reduce risk is by owning stocks in sectors that hold their value, even when times are tough. This inherently will also mean owning more value stocks and fewer growth stocks.
There are different bear market strategies, but they should all amount to reducing risk in your stock portfolio. You can reduce risk by selling stocks, however, studies have shown that market timing is very difficult. Most of us will likely sell out of our stocks at just the wrong time, probably based on emotions rather than a solid rationale. And not only that, it will probably be too late to buy back into the next bull market.
The other way you can reduce risk is by owning stocks in sectors that hold their value, even when times are tough. This inherently will also mean owning more value stocks and fewer growth stocks.
Watch our video
Sector rotation
The concept of sector rotation posits that investors rotate between sectors in accordance with the business cycle and bull and bear markets.
The Red line is the stock market and the green line is the business cycle. The stock market moves ahead of (i.e. in anticipation of) the economy.
The market cycle can be divided into four stages:
- The Market bottom when a long-term low is put in.
- The Bull market is when the market rallies off the market bottom.
- Market top when the bull market reaches its high point.
- The Bear market is when the market drops (but rarely retraces all the gains of the last bull market).
The stock market moves ahead of the economy. So you don’t want to invest in what’s happening now, you want to invest according to what comes next in the cycle. And of course, there lies the risk with investing, you never know for sure what comes next. The goal is to be compensated with investment returns for taking on this risk.
At the top of the chart you can find the main sectors of the stock market. Each sector has characteristics that are preferred by investors at different stages of the business cycle. But again, they do so well ahead of that stage of the business cycle starting.
At the top of the chart you can find the main sectors of the stock market. Each sector has characteristics that are preferred by investors at different stages of the business cycle. But again, they do so well ahead of that stage of the business cycle starting.
These are the stages of the business cycle:
- Full recession - This is a time when businesses are making less money, and people are losing jobs. Usually, interest rates are falling. It’s during this time that the market bottoms as investors rotate into cyclical and transport stocks and into technology and industrials as the market begins the new bull market.
- Early recovery - Here industrial production starts to rise and consumer confidence turns around, while interest rates have bottomed. Now the stock market is in a new bull market. Industrial stocks continue to fare well at the beginning before investors rotate into basic materials and energy stocks as industries demand more commodities.
- Full recovery - Here the economy is getting overheated and interest rates start rising. Consumer confidence is high but industrial production is flat. During this period the stock market is topping. Energy should still do well at the start but then investors rotate into more defensive sectors like consumer staples and healthcare.
- Early recession - Here the economy is starting to look bad. Consumer confidence starts falling as does industrial production. The yield curve might get inverted. Investors get even more defensive and shift into utilities and then financials.
Sector rotation is just a model and models, by their nature, are simplified. It doesn’t always work out just as above, and there is always disagreement about which stage of the business cycle we’re in.
Relative strength as a bear market trading strategy
According to the sector rotation model, the way to invest in a bear market is to rotate more of your portfolio into sectors that hold their value and reduce risk. Those sectors are staples, healthcare, utilities and perhaps financials. The next step is to decide which stocks to own within those sectors.
One way to help decide is to look at the relative performance of stocks in your preferred sectors relative to an industry benchmark. In the Trading 212 app, tap the search icon and tap browse all, after picking an exchange, you can see all the sectors.
One way to help decide is to look at the relative performance of stocks in your preferred sectors relative to an industry benchmark. In the Trading 212 app, tap the search icon and tap browse all, after picking an exchange, you can see all the sectors.
Choose healthcare as one of the bear market-friendly sectors.
Choose Cardinal Health (CAH) as a stock within the healthcare sector.
Note its 1-year and 3-month performance.
Next search for XLV, the ticker for the SPDR US Health Care Sector ETF (XLV).
Then compare the performance of the individual stock with the overall sector.
In this example, the stock has been rising over both time periods while the overall sector is slightly down.
Choose Cardinal Health (CAH) as a stock within the healthcare sector.
Note its 1-year and 3-month performance.
Next search for XLV, the ticker for the SPDR US Health Care Sector ETF (XLV).
Then compare the performance of the individual stock with the overall sector.
In this example, the stock has been rising over both time periods while the overall sector is slightly down.
Another way you can visualise this relative strength is with a relative strength chart. The chart below is from TradingView (the interactive charts on the Trading 212 app are by TradingView).
This chart shows CAH divided by XLV. The concept is similar to a forex pair like EUR/USD i.e. one asset priced in terms of another asset. You can see Cardinal Health has been relatively weaker than the overall healthcare sector over the past few years, but the breakout above a downtrend line demonstrates that more recently, Cardinal Health has done better than its sector, demonstrating ‘relative strength’ vs other healthcare stocks.
CAH and XLV are examples to demonstrate the idea that a stock outperforming its benchmark in a bear market shows it is holding its value better than the industry average.
CAH and XLV are examples to demonstrate the idea that a stock outperforming its benchmark in a bear market shows it is holding its value better than the industry average.
Recap
Strategies that work in bull markets don’t work as well in bear markets. In bear markets, it’s time to switch from capital growth to preservation. Sector rotation is a model that can help decide which sectors to invest in during a bear market and relative strength is a way to pick out strong stocks within a sector.
FAQ
Q: What to invest in a bear market?
When the stock market is in a bear market, it can be difficult to know what to invest in. However, there are a few things that you can look for. First, you want to find companies that are still doing well despite the market conditions. This means that they have a strong business model and are able to weather the storm. Additionally, you want to look for companies with low debt levels. This will help to protect them from any potential financial difficulties. Finally, you want to find companies with a strong track record. This shows that they have been able to weather previous bear markets and are likely to do so again.
Q: Should I keep investing in a bear market?
If you are investing for the long term, then you shouldn’t sell your investments just because the market is going through a down period. Over time, the market will recover, and your investments will likely increase in value. However, if you are investing for the short term, then you may want to reconsider your investment strategy. In a bear market, prices are more likely to continue falling, so you could lose money if you don’t sell your investments.
Q: Is it good to invest in a bear market?
Some investors believe that it is always a good idea to invest in a bear market because you can buy stocks at a lower price and then sell them when the market rebounds. Other investors believe that bear markets are too risky because the prices of stocks can continue to go down for a long time. Ultimately, it is up to the individual investor to decide whether or not to invest in a bear market.
Q: What are good investments in a bear market?
There are a few things to look for when trying to identify good shares investments in a bear market. First, you want to look for companies that have strong balance sheets and are less likely to be impacted by a downturn in the economy. Second, you want to look for companies with solid dividend yields that can provide some income during a market downturn. Lastly, you want to look for companies that are trading at attractive valuations relative to their historical norms.
- Capital appreciation: Focusing on growing the overall value of investments, often by seeking out assets that can rise significantly in price.
- Capital preservation: A defensive investing approach prioritising the protection of existing funds, aiming to avoid large losses rather than chasing high returns.
- Relative strength: A comparison technique that measures how well one share (or sector) performs against a wider market index or peer group over time.
