Beware of the Bear- Five Thoughts

There is only one side of the market and it is not the bull side or the bear side, but the right side. Jesse Livermore

I began my real investment journey* in 2011 amidst the embers of the 2008 Crash, so this is the first Bear Market that I have lived through as an investor in individual stocks, albeit there have been plenty of "Corrections" since then. 

For the uninitiated, a "Correction" is where stocks drop 10% or more from their highs. A "Bear Market" is where stocks drop 20% or more from their highs

I allowed most of my trading portfolio to drop into cash at an early stage of the Drop (through use of trailing stops) and left my long term investment portfolio (which is balanced between equities, gilts, bonds and gold- almost entirely in indices and Investment Trusts & Funds) largely intact. The only major buy I made was an increase of my gold weighting about a month ago. I have spent a fair part of the current Bear Market watching from the sidelines. I've not jumped back in yet and I'll admit that it has been hard to watch the rally of the last week. On one level it has been an interesting exercise in watching the Bear Market Playbook. As I've been reflecting, here are five thoughts that I've had:

1. Whilst Bear Markets are inevitable, Controlling risk is critical

Gordon Brown will perhaps never live down his "no more boom and bust quote" as his leadership ended in one of the worst downturns for a generation. The truth is that downturns always follow good times. We've just enjoyed one of the longest bull markets in history. Something had to end it. I just don't think that anyone thought it would be a Global Pandemic. 

I know people who have been preparing for this for years and have lost a lot of money along the way. I knew someone who was badly burned in the 2008 Crash who has confidently predicted 19 of the last 2 Recessions. Something had to kick us into a Bear Market, because one was overdue. It could have been Global Slowdown, Oil Wars, Trade Wars, Brexit or the Italian Debt Crisis. In the end it was as simple as a a virus.

With bizarre timing, I started this blog in January 2020 when the US Market was at an unnatural high and some stocks on the UK Market had reached toppy valuations. I wrote initially quite a lot about psychology and the need to control risk. One or two did question what I wrote about the need to maintain trailing stop losses. The truth is that risk is at its highest when the Market is at its height. If you are buying genuinely good stock at rock bottom prices risk is conversely much lower.

2. Don't worry about missing out

Those who do not learn the lessons of history are doomed to repeat it (unattributed)

There is a great temptation to jump back into the Market quickly to snap up bargains. For example if you'd bought a basket on stocks on Friday 3rd April 2020 and sold out on Thursday 9th April 2020, the chances are that you would have made some decent money. 

However did you know that in the Crash of 2008, there were two rallies of 20% or more before the Market bottomed. In the DotCom Bear Market of 2000-2003 there were no less than four (probably not helped by the Second Gulf War which prolonged the Misery). If you really want to learn the seminal lessons of history then I recommend reading The Great Crash 1929 by John Kenneth Galbraith. In an era when it was thought that Stocks would carry on going on up for ever, there were a number of sharp rallies in that Bear Market before it bottomed and heralded in the Great Depression. 

Perhaps the most memorable tale is that of Sir Isaac Newton who sold out early during the South Sea Bubble of the 1720's, leaving his capital intact, but saw the mania continue to push the South Sea stock even higher. He was so worried about missing out that he piled back in and ended up nursing really heavy losses.

By all means be brave when there is blood on the streets. Be careful though!

3. It's OK to be hawkish sometimes

It is true that big money is made in times like these. I've written previously about how I made some really good money in the light of the Brexit Referendum result. My personal conviction that this was a UK only problem and realisation would dawn that perfectly good businesses would do fine. 

My gut instinct was right then. I am however definitely more hawkish this time though. The simple reason is that the problem is unquestionably global now. The UK is a cork on the global tide- if it's going out, there is not much that the UK can do about it. The best hope is that vaccines are found quickly and the World can get back to normal. That is however an optimistic scenario. The truth is that there is going to be a lot of pain felt before we do. 

The only glimmer for UK stocks is that due to the debilitating political response to the Brexit vote, UK stocks have lagged global stocks for some time now and they came into this at valuations that were much more rational than (for example) their US counterparts. The drops have presented some genuine bargains. The key is however to be patient and wait to see how businesses survive and adapt to the present crisis. 

Dart (DTG) is an interesting case in point. Its stock on April 11th 2020 sits at just over a third of its market highs, whilst at the same time being more than double its March Market bottom. It's an airline and holiday package stock with a decent level of cash. I have genuinely no idea how thing will play out for that sector.  Clearly the Market thinks that DTG will survive and given its results coming into the Crash, there was every reason to believe that it would thrive given the drop in competition. But how confident can you be? I am inclined to wait patiently.

4. Balance Sheet strength is critical

Commentators seem united in the view that we are going to enter Recession. If however we are now entering the worst Recession in living memory, one sure way that you can protect your capital is to ensure that companies you buy the shares in have strong balance sheets. That means cash on the balance sheet, low or very manageable levels of debt, good credit risk etc. Not only have they got a better than average chance of surviving but Darwinian Laws will come into play and they will see their weaker competitors killed off leaving more of the Market for them. 

There is a prevailing view that too many "zombie companies" were allowed to survive in 2008-2010 due to dovish Bank policies and rock bottom interest rates. It is possible that these companies will not survive this recession. Make sure that you don't end being an equity investor in one of these.

5. Less can be More

This is a time when pound cost averaging can really come into its own. If you spot good companies that have been oversold and are unlikely to go bust but don't want to take the risk of them plunging lower in price, what do you do?

The answer is to take a nibble now but buy less than you would normally. If they go up then you can average up by buying some more. Very soon you will have built up a nice margin of safety. Conversely if they go down and breach your stop loss (which you can perhaps set further away at 15% or more to avoid pesky Volatility) and get stopped out, you won't have lost much.

I cannot guarantee that you will make lots of money from following the rational behind these five thoughts. What I can be more confident of is that you will be there to fight another day. The Stock Market is a long term game and big money is usually made over time by following a long term game-plan.

* This blog is published subject to the usual disclaimer