How to Prepare for the Next Bear Market
At our Private Wealth Symposium in Sea Island, Georgia, last week, I talked about several investments that are good to own late in a bull market.
"But if every bull market is followed by a bear market," one attendee asked at the cocktail reception, "why not just get the heck out now?"
Seems like a reasonable question. Especially if you assume that the next bear market is just around the corner.
But that is far from certain. This bull market may last four more weeks, four more months or four more years.
If you sit on the sidelines too long, you'll miss out on the kind of returns that only equities can give. And, after a while, you start thinking about getting back into the market.
But having missed the rally, you now risk being in for the correction... or worse.
That's why it's almost always a bad idea to bail on stocks entirely. (Benjamin Graham, Warren Buffett's mentor, advised never having less than 30% of your money in stocks.) Here are five practical steps you can and should take now to prepare for the inevitable, the next bear market:
- Rebalance your portfolio. We're 5 1/2 years into this bull market. Large cap stocks have more than doubled. Small caps have more than tripled. That means the percentage of your portfolio in equities is a lot bigger than it was a few years ago. So trim back your equity positions and add to other assets that have lagged. Every asset class moves in cycles - and rebalancing is a proven way to boost your returns while reducing overall portfolio risk.
- Gravitate toward value stocks. Growth stocks are excellent investments, especially early in a bull market. But they carry higher valuations and when growth starts to fade, look out below. Value stocks, by comparison, are companies that are cheap relative to their sales, earnings, dividends and book value. They not only generate superior returns over the long term, they do it with a higher margin of safety.
- Look overseas. The U.S. market has had a heckuva run since bottoming in March 2009. But you can find stronger growth today in countries like China, India and Brazil. And you can find better values in Europe and Asia. Plus, positive change is afoot in many countries. For instance, Japan's Prime Minister Shinzo Abe is reducing tax rates, improving corporate governance, relaxing visa requirements and deregulating industry. These are exactly the kinds of moves that will get the Japanese economy - and the Nikkei 225 - moving the right way.
- Focus on larger companies. It's well known on Wall Street that small companies tend to outperform early in a bull market and larger ones do better "on the back nine." This bull is now a senior citizen, so it's a good time to shift your holdings away from riskier, more volatile small caps and toward large caps. Or, better still, megacaps, the world's largest publicly traded companies.
- Adjust those stops. I see something eerily familiar happen with each bull market. Investors - fully understanding how trailing stops protect both their principal and their profits - start to get complacent. They quit ratcheting up their stops. They start complaining about the stocks that went back up after they stopped out. And so they quit using stops... just when they need them most. A bear market takes the market lower than most people think it will go. (Often 40% or more.) Stopping out early keeps your profits from slipping through your fingers. It may also mean you realize a small loss. But it keeps small losses from turning into unacceptable ones.
Stick with these five principles and you'll have a big advantage over investors who flee the market and miss the remaining upside. But you'll also have a big advantage over those who stay and don't cover their behinds.
Editor's Note: Speaking of value stocks, Alex recently discovered three of them likely to experience the market's most powerful "Buy" signal... starting next week. Opportunities like this are rare. To learn more, click here.