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On The Edge Of A Bear Market: Now What?

Published 05/21/2022, 03:55 AM
Updated 08/10/2023, 07:18 AM
  • The market is approaching bear market levels
  • Whether or not it gets there, the market environment has changed
  • There are a few steps investors can take to make sure they get to the other side
  • For tools, data, and content to help you make better investing decisions, try InvestingPro+»

On Friday, May 20th, the S&P 500 officially crossed into bear market territory, commonly defined as a 20% drop. It only happened for a few hours before the S&P 500 rallied to finish just above that threshold, but we remain on the precipice. The Dow Jones Industrial Average is only down 15% from highs, and the NASDAQ Composite remains down 30%. Setting aside the technicalities, the sudden sell-offs in stocks like Wal-Mart (NYSE:WMT) or Cisco (NASDAQ:CSCO), combined with the stock market ‘generals’ like Apple (NASDAQ:AAPL) or Alphabet (NASDAQ:GOOGL) being down more than 25%, leave us with the feeling that something has definitively changed.

One of our challenges as investors is to maintain discipline with our long-term principles while also updating our understanding of the markets when facts change. There’s nothing like the hammer of a big round number like a 20% drop, with BEAR MARKET in flashing red letters, to confront that dilemma.

Like many investors, I haven’t really gone through a full bear market – I started investing in 2011. 2018 was close to a bear market, but we rebounded just before the 20% mark and returned to the 2010s upwards trend heading into the pandemic. The March 2020 crash was officially a bear market, but markets rebounded so quickly that it’s hard to count that (small-cap investors like myself can argue we got hit harder, but still, everyone saw a full recovery and then some within a year or so).

While it’s possible we repeat 2018 and shake off the bear market scare on a return to new heights, I’d be surprised. So instead, here are some ideas to adjust:

Pull Up The Anchors

The last two years have been very weird. We had a pandemic which was a huge global health risk, the response to that required economic disruptions, and the response to that was high government spending and loose monetary policy. This all happened on the tail of a 10-year+ bull market that left many equities with stretched valuations.

I say that not to rehash the policy or economic or investing choices behind all that, but to point out that the prices we saw in the last two years are meaningless. As famed venture capitalist and tech investor Bill Gurley put it: "1) Previous "all-time" highs are completely irrelevant. It's not "cheap" because it is down 70%. Forget those prices happened."

Trends we thought might stick forever during the pandemic, like work from everywhere via Zoom (NASDAQ:ZM) or shopping online, have proven to be less durable. Trends we thought might fade, like inflation, have not. And all the while, markets have seemed content to price things as if only the last quarter and the next quarter matter. This creates opportunities, but it also makes it easy to get sucked in.

We remain in a fluctuating environment, where some of the changes in the last couple years will stick, other changes we didn’t anticipate will emerge, some things will go back to exactly the way they were before, and others will revert to how they were before but with real changes. We are investing in moving targets. The highs of March 2021 or January 2022 are no more helpful to hitting those targets than the lows of March 2020.

Stick To Durable Assets

“Price is what you pay, value is what you get,” goes the old Warren Buffett saying. One of the things we can control as investors is making sure we know what we own, and we know that they can make it through any sort of scenario. Companies that can survive recessions and even produce profit during them will often come out the other side stronger. But if your companies don’t make it to the other side, that rebound won’t help.

In the Covid sell-off, I didn’t sell anything at the bottom, but looked at extreme ‘what if the economy is shut down for a year’ scenarios for my portfolio. In the initial rebound I dumped Garrett Motion (NASDAQ:GTX), a company with a leveraged balance sheet at the time, exposed to an industry I’m not crazy about (autos), and with some litigation issues. The company worked out for some people, but at the time, it felt like the wrong sort of ‘worst-case scenario’ stock to hold through the pandemic.

This time around, the scenario is more gradual decay of margins, shifting demand, or lost competitive power that scares me. I’m starting to dump Just Eat Takeaway (OTC:JTKWY) – leverage on the balance sheet and it just seems like they’re not hacking it with the competition – and taking a much harsher look at AerCap (NYSE:AER), which I think is fine from a downside protection perspective but where the upside may not be worth it.

Whatever your risk scenario is, it’s worth making sure your companies will survive it (and if you are a crypto investor, well, good luck). It’s true that ‘junkier’ names will pop more whenever we get to the other side of a bear market. But ‘getting to the other side’ is a big part of the equation.

Look Forward

The corollary to that point is that it’s important to analyze companies and understand how they will perform. It’s not enough to take a trailing twelve months’ price to earnings ratio for, say, Target (NYSE:TGT), and say ‘under 13x, looks pretty good!”

Are people going to continue to spend at Target as government spending decreases and maybe even consumer spending takes a hit? Or can Target maintain their operating margins, the big question from the recent call? And can Target prepare for widely shifting spending patterns?

The same sorts of questions apply to consumer discretionary companies, or home builders, or commodity plays. When the game changes, how do these companies fare?

Take What The Market Gives

One of the greatest tricks the market pulled on value investors over the last 2 years or 12 years, depending on how you look at it, was to suck them into growth investing.

“Over a long enough time horizon, revenue growth is all that really matters,” the market told us.

“Compounders are good, value traps are bad,” the market argued.

“I’d rather buy a great company at a fair price than a fair company at a great price,” famed growth investor, err, Warren Buffett said.

Buffett’s point, coming from the value investor, highlights the importance of an open mind. I know I felt pressure over the last few years to open my portfolio to more tech companies with recurring revenue business models and sexy growth numbers. Take Duolingo (NASDAQ:DUOL): I really like it as a user, think they have a strong growth story, one the company has convincingly argued is not Covid fueled, and the rare tech-adjacent stock where revenue growth might accelerate. That's good.

I also don’t know when Duolingo will become profitable given their promises to continue to invest a lot in research and development. Is there a price where I won’t care about that? Maybe, but it’s a lot lower than it would have been in last year’s "growth still works" market.

Instead, companies that should have marginal operating momentum in 2022, or companies that have solid profitability and clean valuations, are the ones I’m looking to add to. Travel companies should see improving numbers and some of them still have fair valuations – I own and want to add to Booking Holdings (NASDAQ:BKNG) and Grupo Aeroportuario del Centro Norte SAB de CV (NASDAQ:OMAB). Financials benefit from higher interest rates, and I’ve added shares of Discover Financial Services (NYSE:DFS) in this downturn to my portfolio.

Will it be enough to stave off losses? Maybe not, but they’re all good companies that should perform well on a fundamental basis in the next 12-24 months.

The 2010s Bull Market Is Gone

I said earlier that we should throw out the pandemic-era prices as reference points. It is worth looking back to the dot com bust, though. There, a spate of new technology companies soared to incredible heights as investors bet on disruption, limitless growth, and modern metrics. It also dragged a lot of blue-chip stocks and the broader market to new heights. Then, the bear market set in, and the Nasdaq lagged for a good decade.

The 2010s were the buy the dip market, the tech disruptor market, the software as a service market, and the quality >> value market. The market wasn’t wrong in its pricing, as investors understood the value of recurring revenue and the power of new business models.

But, it’s not helpful to assume that what worked then will work going forward, any more than it helped in the 2010s when permabears kept expecting the next crash around the corner. A lot of the disruptive fields of the last decade have been disrupted, over funded, and left bereft of upside – food delivery ala Just Eat Takeaway is a good example.

We may rally again like in 2018. Some of the winners from the 2020s will look like 2010s winners. And at the same time, resetting the playbook for a new environment will be a good idea.

This Too Shall Pass

Bear markets are not fun for anybody but those permabears (who, as I said, often miss out on the upside). But they do pass. The 1970s were a tough period, as were the 2000s: the markets that followed were huge bull market runs.

This doesn’t seem to me like an end of the world situation for the economy. Unemployment is very low, consumer spending remains strong, and corporate profits are high. Corporate profits and margins will probably take a hit, which causes both the recession and a bear market, but the current environment looks less scary than both the 2008 financial crisis and the 2020 pandemic crash, at least that initial March stretch.

So, investors need to protect ourselves, update our thinking, and prepare. But, if we’re investing with money meant for the long term, have more cash in our portfolio to invest, and hold positions in companies with stable balance sheets and good prospects, we have the luxury of also being patient. The bear market will be a test, so we’ll need that patience.

***

The current market makes it harder than ever to make the right decisions. Think about the challenges:

  • Inflation

  • Geopolitical turmoil

  • Disruptive technologies

  • Interest rate hikes

To handle them, you need good data, effective tools to sort through the data, and insights into what it all means. You need to take emotion out of investing and focus on the fundamentals.

For that, there’s InvestingPro+, with all the professional data and tools you need to make better investing decisions. Learn More »

Disclaimer I am long AAPL, JTKWY, DFS, AER, OMAB, and BKNG, and considering selling both JTKWY and AER, and considering buying TGT and more DFS and BKNG.

Latest comments

You can try oil stocks at least
If you dont know shorting just wait for GOP comes back
Down 50% from here. Don't try to catch a falling knife.
I'd argue the current situation looks just as bad if not worst than covid crash as the fed doesn't have much room to help agaist a recession whilst fighting inflation the developed world housing markets is so far out of whack its ridiculous.
and the average consumer won't be able to keep up spending with falling real wages, deposable incomes and the lowest saving rates in a decade whilst consumer credit seems the be exploding in the last few months. unfortunately it looks like many countries across the world are heading for a recession with central banks lacking tools to fight it.
 I know people who, once the Fed made its full commitment to support financial markets right around the bottom and Congress passed the first stimulus, recognized that the markets were going to stabilize. But for me, there was still an element of ‘my god, what could happen next’ through, say, April, that is not at all like the current moment. Inflation is bad, your points are not wrong, but it’s less scary to me. I think where we probably disagree is on the strength of the consumer; I think they’re in better shape than you say, and even a brief recession - which central banks more or less want - won’t alter that. But we’ll see. I was wrong about inflation and wrong in April 2020, so I stake no claim to macroeconomic forecasting.
Daniel, excellent article. However, the world is still awash in money on the sidelines, the government debt is unmanageable at low to moderate interest rates, and the Fed IS political.  I do not think the irrational market is finished.  Recovery in the fall.  Drop in January.
Thanks for the comment, Joe. Not sure I agree with everything, but it’s interesting. Irrational market meaning the ever going higher market?
I've learned alot in last 2 & half years, which is how long I've been investing and trading. Lost so much money bag holding. The rotation makes sense to me, however my problem is that I am tech heavy, and not sure which equities are more junk, and which are more promising! take Apple vs Palantir. Affirm, UPST, Robinhood? I parked money in many of these names. Thought I was diversified, but maybe not. I feel like I have to hold now, or I'm stuck!
It’s an interesting point about yech, Nick. Those are all young, tech enabled companies, Apple aside on the young front, but in different end markets. I think the challenge is they all went up from the same investor base, so they are sll going down together. It may take time for those investors to get shaken out and for the companies to decouple from each other.In any case, that is the reality of markets, you learn lessons from your mistakes, it’s happened to me a lot!
I think the money will rotate out of tech sector and with reset, it will flow into commodity stocks and energy for upcoming years. Tech, crypto etc is good to speculate (flying cars etc) when resources are abundant. But we dont have enough resources (commodities) So i think real value like energy and commodities will have money inflow
Thanks for the comment, can ork, what you say makes a lot of sense.
I think you need to trade the interest rates circle…for example, i am short in all financial products (stocks,bonds,cryptos)…i have removed all my personal funds 3 months ago in to a 3 months saving accounts (locked) that pays 1,5%…and will increase in the coming months and it can pay up to 2,5% or even 3%,this is the most safe bet in bearish markets…..and i believe by next year or maybe year and half, as soon as they stop increasing the rates, i will start buying stocks,bonds,cryptos…long term trading! Trade like the big boys…
Kyriakos, thanks for commenting. The comment may have cut off, but what are you watching for to take off the shorts, never mind go long?
thought the same, you can scroll…
good call Antonio, didn’t get my thumb right on my phone! All my questions answered. The one challenge is if inflation sticks a 3% savings rate doesn’t do much.
what on the edge of bear market? Be realistic. It has already been a bear market !
(Pushes glasses to bridge of the nose) well actually…No, I take your point. Small caps and tech are already in bear markets, and the other indices are probably not there yet because of energy. The official term of bear market is a little silly - 20% doesn’t feel much worse than 19% - but it is useful as a prod to reconsider things.
So why will there never be a new high? Because population is too high even after Covid deaths.
Thanks for commenting Murali. Your argument is basically that we are in a Malthusian state and never reach, say, 5000 on the S&P as a result? Because with that time horizon I would be happy to take the bet. 😀
Only when the hope and dream of a new high fades off, their smiles will fade off and they will sell and sell. That is when market will bottom. The sooner that happens, but it won't, the better it will be for market.
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