Caught Off Guard by the Bear

At a recent meeting of the Northern Ohio Chapter of the CMT Association, we had a roundtable discussion where each attendee shared their thoughts on the market environment.

One of the junior members of the gathering gave a rather dire outlook for stocks, followed by the remark, "I've never traded a bear market before."

That's right, anyone that began investing since 2010 has known nothing but a bull market.

In a similar vein, anyone born after say 1960 has never really seen a rising rate environment.

Why is this important?  At some point in the potentially near future, a huge cohort of investors will be entering a market environment in which they have absolutely zero experience.

I started in this industry in the year 2000.  My first two years closely following the financial markets included: a secular bear market, decimalization, early days of the Euro, 9/11 and the aftermath, elevated volatility, shrinking returns. 

Needless to say, I quickly became skeptical of the long-term value proposition of the equity markets.  This served me well in 2007, when I looked to the left on the chart of the S&P 500 and saw the 2000 high looming large. 

However, this did not serve me well in 2013, when I recognized the S&P 500 reaching the same levels and once again became bearish.  I learned a valuable lesson in the value of trend following and the danger of confirmation bias.

All large losses begin as small losses.
— Unknown, but it sounds like something Ned Davis would say

When will a bear market happen in the US?  I'm not sure.  Actually, no one is sure.  But here are three ways you can prepare yourself for the bear market that will absolutely, positively, certainly happen at some point.

1) Focus on what the market does, not what it should do.

Many investors and market prognosticators talk about cause and effect relationships with way too much certainty.  "Banks should go down because of interest rates."  "Gold should go up because of XYZ."

I've often found that the causes of bull and bear markets become evident well after the markets are already in motion.  Better to focus on the markets themselves so you won't be caught off guard when things really start to get ugly.

As part of my regular chart routine, I review all markets of interest that have hit new highs or new lows.  Frontier markets were a solid bet in 2017 through early 2018, handily outperforming the S&P 500.  A couple months ago, that all started to change.

By focusing on the movements of the markets, you will see when the tides are shifting, and hopefully be able to take action before a small loss becomes a large loss.

2) Set price alerts for everything you hold dear.

For those of you that don't spend every morning looking at charts, there are still ways to stay informed.  Welcome to the beauty of automated price alerts.

For any market of interest that is in an uptrend, I have price alerts set for the "line in the sand" that would cause me to revisit a bullish thesis.

For the SPX, that means focusing on the February low around 2540 (first blue rectangle).  When the S&P breaks below that level, I'll get an alert, and I'll know that the market has set a lower low.

Does that mean I need to instantly become bearish?  Of course not.  But it does tell me I need to revisit the thesis and evaluate the price action around that key level.

3) Learn from others that have done this before.

At the end of every semester, I would tell my students at Brandeis University to "always be a student of the markets."  The investors I respect the most don't feel they have all the answers.  They focus more on the questions that need to be asked.

Early in my career, I had the privilege of speaking regularly with traders and investors with years of experience over various market cycles.  I tried to ask as many questions as possible and learn from these people that had survived previous bear markets and lived to tell the tale.

When the market rallied in 2010-2011, I enjoyed speaking with money managers who had run funds in the 1970s and 1980s.  I especially appreciated talking with Bill Doane, who ran the Fidelity technical research team around that period, and my friend Walter Deemer who was at Putnam.

A former colleague of mine loved to read books that were published during previous bull and bear market cycles.  While the conditions are often very different, you can learn a great deal about the mindset of investors and the prevailing wisdom of these historical periods.

For those investors that focus on price, set alerts, and learn from others, they will find it very difficult to be caught off guard by the bear.


PS- I'll be speaking next Wednesday 7/11 at the CMT Association New York chapter.  Great opportunity to shake some hands and learn from others!  More info here.

Disclaimer: This blog is for educational purposes only, and should not be construed as financial advice.  Please see the Disclaimer page for full details.