While the major stock indices may not yet be in a technical bear market, many stocks and sectors are already. What we are seeing now is rotational action in which the sellers incrementally go after the stocks that have held up. This past week the FANG stocks -- Facebook (FB), Amazon (AMZN), Netflix (NFLX), Google/Alphabet (GOOG, GOOGL) -- were a good illustration of this rolling bear market.
It is likely that bear market conditions may exist for some time to come. I've discussed my reasons for this thesis quite a bit lately on Real Money, but all we have to do is to look at the price action to know that we have some issues.
Don't Freeze
The most important thing not to do when confronted with bear market action is to freeze. The folks who suffered the most in 2000 and 2008 where those who "stayed the course." We are bombarded by "experts" who tell us the timing is futile and that we should just hold for the long term. When we finally do have a real bear market, the articles about how buy-and-hold is dead start to appear as people look at years of gains being wiped out quickly.
The key to taking action to protect yourself is to think of selling as just a form of temporary insurance. Have a plan to get back into your favorite stocks even if you have to pay a bit higher. Transaction costs are nil but the peace of mind you can gain from being temporarily on the sidelines is tremendous.
The biggest losses most people suffer are generally a product of doing nothing. A stock acts poorly and they just freeze. They don't know what to do and there is always a chorus of loud voices on Wall Street telling them to stay with it and buy even more.
Sometimes it's better to simply act rather than to endlessly contemplate whether you are doing the right thing. The stock market allows you to change your mind quite easily but too many people don't seem to appreciate that fact. They seem to believe that selling something is a monumental decision that can't be undone when in reality it is the easiest thing in the world.
Cash Is King
If you want to navigate a bear market you have to appreciate the great value of cash. High levels of cash not only give you flexibility but it gives you objectivity. When people are heavily invested, they tend to hope and pray that the worst is over. They engage in data mining and look for evidence to support what they want to see. A heavily invested bull in a downtrending market has an amazing capacity to find positives.
Keep in mind that mutual funds have very different ideas as to what is a high level of cash. In that world 10% cash may be a very high allocation. Individual investors are many times more flexible and can easily go 100% cash at times. It is very liberating to clear the decks occasionally, especially when you are going through a tough period.
Timeframes
It is extremely important in bear markets to be aware of your timeframes. There are always great tradable bounces but far too often people let a failed trade turn into an investment. That may work in a bull market when the uptrend bails you out but in a downtrending market you can be buried quickly.
If you are looking to buy for the long run then make sure you do so incrementally and have a plan to exit if your thesis should be proven wrong. The big mistake that most people make is averaging into a favorite stock too big and too fast. It is important to catch trends so look to average up rather than down.
Don't Try to Predict the Bottom
In downtrends there are constant predictions of bottoms. Every pundit wants to be the genius that predicts the exact low. It can become an obsession and can push you to lose sight of the bigger issue, which is to catch a trend rather than a bottom. When the market does hit bottom and things improve, you will have plenty of time to put cash to work. Precise timing won't make that big of a difference why you are looking at major trends.
I've often written that bear markets don't scare you out, they wear you out. Most of the time bottoms are obvious in the rear-view mirror. There isn't any major signal that will tell us when the worst is over. Generally, the bottom is a product of disgust and dismay more than any other emotions.
Going Short Isn't the Inverse of Going Long
Stocks don't go down the same way they go up. They fall apart abruptly and much faster. It is necessary to be more anticipatory and when they do reverse, the squeezes can be very painful. If you are going to play the short side, make sure that your methodology isn't just the inverse of what you do in bull markets. Shorting can be immensely profitable but it is a very different game and requires not only the right mindset but a different strategy.
Bear markets can be very tiring, so it is important to maintain a positive mindset. The cycle will end and great opportunities will develop. While the action we are watching may be downright depressing at times, it is going to lead to great profits. We just have to be patient and stay positive.
