Beware of the Bear

11th Apr '20 by Sharechap

14 comments 809 reads

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 writing

Unlock with Email

Unlock with Google

Already have an account?
Login here

William K

12th Apr '20

Many thanks Sharechap. An intelligent and well-argued summary of recent events. All the same I remain confused. Whilst the crash is easily explained by the prospects of a world recession, the recent bull market is not so easily explained - why have share prices rallied around 20% when the future looks bleak and uncertain. Is this a behavioural phenomenon? Are investors celebrating the end of the pandemic too soon? Or is there nowhere else for them to put their money?

My other question is why have some shares in the same sector, with similar metrics on the whole, recovered at different rates? For example, Scottish Mortgage Investment Trust (LON:SMT) has risen to within 8% of its 52 week high, whilst Liontrust Asset Management (LON:LIO) is 27% away from its 52 week high. This makes no sense to me.

My current strategy is based on the assumption that the current bull market must plateau very soon, or that prices will fall. I have started cautiously buying tiny amounts of stock with the intention of averaging down with each 10% fall in the share price provided that the fall in share price is directly proportional to the fall in the relevant index. I don't want to miss out on easy and quick profits, but I believe that there's good chance that the markets will find a new bottom when the full extent of the forthcoming recession is known.

john2

Just to point out that your unattributed quote was actually from George Santayana - ' Those who do not remember the past are condemned to repeat it'.

Sharechap

I had thought too that it was Santayana, but others have claimed it was not him originally! I hedged.....

Thank you. I share your puzzlement. There are two explanations I can come up with:
(a) Markets are not rational in these times and and big up or down tick is magnified these days through much more automatic trading. What has happened though is straight out of the Bear Market playbook.
(b) I personally think that we are in for a heck of a downturn, albeit I also think it will be short and sharp. So perhaps the recent sell off went too far and the past week’s recovery is just a rebalancing, albeit one that went too far on the upside.

The investment trust thing is puzzling. I hold the Scottish Mortgage Investment Trust and it is the best performer in my portfolio. Worthy of greater research....

shipoffrogs

£SMIT and Liontrust Asset Management (LON:LIO) - aren't you comparing apples with pears? One is an investment trust and the other an asset manager.
Liontrust had a heady run in the months before things turned sour and was priced at a premium for the sector, and still is. It also recently announced a hefty acquisition which may pr may not look so attractive in these very uncertain times.

timarr

Whilst the crash is easily explained by the prospects of a world recession, the recent bull market is not so easily explained - why have share prices rallied around 20% when the future looks bleak and uncertain. Is this a behavioural phenomenon?

Hi wilkonz

Bear market bounces following a crash are very common. In many cases we've seen stocks that were priced to definitely go bust recovering to where they're priced to probably go bust, so it's not exactly a surefire go-go bull market signal.

Technically this looks a lot of shorts being closed out and then private investors buying into the subsequent rally out of fear that they'll miss out - the average deal size since the start of the collapse is significantly smaller than pre-crisis, indicating that we're seeing a lot of retail rather than institutional trading. None of which is exactly a positive long-term indication - although given that governments seem determined to throw money at the problem like it's going out of fashion we know at least that there's lots of liquidity around.

Liontrust Asset Management (LON:LIO) are an excellent company but they did look overvalued coming into the downturn. The sustainable investment theme has played very well, small investors love a story, but it did push the share price up rather a lot. Scottish Mortgage Investment Trust (LON:SMT), on the other hand, have a portfolio (Tesla apart) that seems designed to ride the storm in comfort, populated by companies like Amazon, Alibaba, DeliveryHero, Facebook, Shopify, Spotify and Alphabet. And if you look at their full portfolio, right at the bottom of their listed holdings is a small stake is some company called Zoom.

Predictions in this type of market are for fools. We can, however, see that there's a recession coming and almost certainly a tick-up in inflation. Neither of those things will be good for stocks across the board so positioning appropriately is important. We may have already seen the bottom, but nobody actually knows so I think your strategy of averaging down is correct: I just think we need to try and avoid sectors where there's a lot of pain to come, regardless of how good the companies are and how far their prices have dropped.

Well it's easily verified. The Life of Reason: Reason in Common Sense, page 284.

Thanks. Yes, Scottish Mortgage Investment Trust (LON:SMT) and Liontrust Asset Management (LON:LIO) are rather apples and pears, apart from both being successful companies in the financial sector they do both function in different ways. (I hold both.) I guess Liontrust Asset Management (LON:LIO) was overvalued, perhaps because it was pushed hard by ST in IC. I did buy a few more Scottish Mortgage last week as they seemed well priced and they are invested in companies likely to bounce back strongly - at least in my opinion. The 10% stake in Tesla may well prove to be a very shrewd investment. If Scottish Mortgage fall to 500 pence again, which is quite possible in this mad market, I'll buy more.

WarrantStar

I do not think that pound cost averaging on a falling share is a good idea. The best way to approach a falling share is to avoid it. However, when it has risen for may be a week then it is more likely to keep rising than to resume falling. If you were to keep buying a share that was falling then you would incur unnecessary losses. Better to be patient and wait to buy at a lower price.

Hi WarrantStar. Normally I would agree with you, but these are not normal times. To be clear, I would only follow this strategy with good quality shares that are moving in line with the market. In January 2019, for example, Apple fell to $145 from a high of $230 and then rose swiftly to $320 - and a lot of other top US shares dipped before recovering strongly. There are two factors, in my opinion, to consider. One, will the company be trading profitably in 10 years time? Two, is the current price attractive? If the answer to both questions is yes then I'd consider buying and averaging down.

LongValue

Averaging down seems to be based upon the assumption that there will be a reversion to the mean. That is not always the case. Industries, currencies and even countries have come and gone. As a general rule, I would avoid averaging down on small, often illiquid, stocks where the flow of information is controlled by the management. And never get over-exposed to any one stock - no matter how big or illustrious the company.

As you point out, balance sheet strength is key. But faced with a collapse in both supply and demand, figuring out the true value of a quoted company can be very difficult. Most UK listed companies appear to be not only abandoning their dividends but they are also not providing guidance as to their future financial performance. And on the lifting of the lockdown, there could be structural changes in consumer behaviour that the market is yet to factor in.

I believe that we are probably in uncharted waters and reference to past share price patterns may be of little value when assessing many companies.

Sorry if I wasn’t clear enough in the article. I don’t advocate averaging down albeit appreciate that use of the phrase “pound cost averaging” can sometimes be a proxy for it. As I went on to say, I still advocate stop loss usage to cap losses on the downside.

14th Apr '20

ShareChap Thank you for posting such a good piece! The part that resonates most with me is in section 1) "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." In all the turmoil it is good to hold onto your relatively simple point. The other thing to bare in mind , is that the potential rewards are also higher after a big market fall. But the best thing about all this is that it is something that we can actually put into practice (assuming that we have the funds available).

Wilkonz Thank you for your reply. You make a good point. I will give some thought to the question of how to make use of it.

Beware of the Bear

Unlock the rest of this article with a 14 day trial

About the Author

Sharechap

14 comments

Unlock the metrics for all these stocks and more...

Unlock the metrics for all these stocks and more...