Investing in a bear market

The sharemarket is firmly in negative territory, but don’t panic. TIM TREADGOLD explains the rules of bear market survival and reveals the sectors that will bounce back fastest.

By Tim Treadgold

The sharemarket is firmly in negative territory, but don’t panic. We explain the rules of bear market survival and reveals the sectors that will bounce back fastest.

Are we there yet? It’s a question asked by children on a long holiday drive – and by investors praying for a bottom to the bear market. Both get the same answer: Not yet! Keep quiet. Be patient.

Unfortunately, investors often can’t resist the temptation to dabble in the market, because they think they see a bargain or because they believe they can profit from short-term upticks.

There will be some bargains, but all too often it will be a case of catching a falling knife, with painful results.

Bear markets, as everyone holding any form of investment (other than cash) will have noticed, are totally different to bull markets; not just in the obvious way of falling versus rising. The other big differences include:

The time factor. Bear markets are generally slow moving affairs, other than when triggered by a crash, such as that in October 1987 when the price correction was over in a matter of weeks. This bear market is a classic, slow-motion, meltdown.

People do not just feel poorer, they are poorer. And that means most “buy” tips are a fatuous waste of space because very few investors have the funds, or the courage, to do anything. The only people saying buy today are brokers who are panicking as their fee income dries up. On 30 June, for example, Goldman Sachs recommended buying Woodside Petroleum at $67.50. The stock has since fallen to $52.73. Wesfarmers was another Goldman buy tip at $37.30. It is now $34.40.

Living through a bear market requires a change of mindset, especially after emerging from a long-run bull market when everyone who invested in almost anything looked smart.

The rules for bear market survival include:

Be happy with a low return on your investments. This is a time when even a zero return can look good when measured against the 26% fall in industrial stocks over the past year, the 27% fall in resources, and the 20% fall in small industrial stocks.

Cash really is king. Hold cash either as an 8% at-call deposit, or as a nest-egg waiting to indulge in a spot of bottom fishing.

If you haven’t trimmed your portfolio yet, it’s probably too late. Most measures show that we are roughly half-way down, perhaps more, with a final drop in index values to around 40% below the peak likely to signal “we’re there”.

If you have got cash reserves, sit on them for a bit longer. The brokers might be saying buy, but remember they have a personal reason in seeing you trade. It’s far better to be sure that all the bad news is out, and perhaps miss the absolute bottom, than re-enter a market too quickly.

So what’s happened over the past year to cause this bear market? Essentially, the US banking system has collapsed, and the cost of that failure is flowing across the world. Secondly, the resources boom has triggered a global outbreak of inflation, as well as sharply higher oil prices – and both the inflation and the higher oil prices are sending out their own shockwaves.

Older observers of financial markets have seen times like this before, and while no-one likes old-timers reminiscing, anyone in their late 50s has seen at least nine previous bear markets, starting in 1969 with a 34.7% downturn after the Poseidon nickel boom.

That post-Poseidon downturn, however, was nothing compared to the 58.2% “slow motion crash” which was the 1970s, with its oil shocks, stagflation (stagnation plus inflation), and disputable music.

Today (not that this is something generations X and Y want to hear) but events and market conditions feel horribly like the 70s – oil shocks, slow growth plus inflation… and rap music.

Just as there are parallels with the 1970s there are also differences. Back then far fewer people owned shares or investment properties. Life moved at a slower pace. Mobile phones had not been invented, nor had the internet.

Today, most people have some form of exposure to the sharemarket, either directly or via a superannuation account, and everyone feels poorer. That’s one reason why shares in the retail sector have been hit so hard in this downturn. Apart from food, and plasma television sets to watch the Olympics, we have stopped shopping.

Buckling up for a long-term decline is a totally foreign experience for younger generations who expect instant answers. They don’t understand that some things take time, or that the fun (and easy profits) of the bull markets of the past 20 years have gone, certainly for years, and perhaps a decade.

Conditions in property and sharemarkets today really are the worst in 30 years, and possibly the worst since the 1930s.

But – and this is a “but” with a capital B – there will eventually be a recovery, and Australia will be one of the principal beneficiaries of the rebound because our national accounts are in good order, the Federal Government budget is richly in surplus, and China, with its central command economy, cannot afford to stop its dramatic growth. To do so would risk a rural revolt, especially after every peasant in the countryside sees the wealth of the cities on television during the Olympics.

That leaves two questions for investors to consider; when will we touch the bottom, and where to start repairing a damaged portfolio?

Two useful ways of addressing the “when” question are (a) to compare this bear market with previous bear markets, and (b) look at another interesting pointer, the Coppock Indicator.

If comparing this bear market with the 1970s is a fair comparison, then we are in for another year of depressing news as the banks repair their balance sheets, and oil prices subside – simply because demand has dropped courtesy of a worldwide recession.

The last bear market, in the wake of the year 2000 tech-wreck, lasted about 18 months, and that means we have another year to survive before recovery starts.

The Coppock Indicator (named after a 1950s economist, Edwin Coppock) is a curious pointer to the possible start of the next bull market. Essentially, it measures the bottom of the market, but not for how long the market will stay on the bottom.

Last week, in SmartCompany’s sister publication, Eureka Report, Rudi Filapek-Vandyck, reported the first indication of the Coppock below zero in this cycle, a pointer to a bottom forming.

The trick now is knowing how long we will be at the bottom. To assess that you can use Coppock’s semi-Biblical measure based on the time taken to mourn a death in the family – with that event being a proxy for a bear market. The consensus was that mourning lasts between 11 and 14 months – which takes us back to the fact that we might have a year of the bear to run, and that time is on your side before rushing back into the market.

When you make your move back into the market there are some safe starting points, including:

Banks. The classic re-entry point after a bear market, simply because Australia’s big four banks, Westpac, NAB, ANZ and CBA, have the luxury of a de-facto government guarantee, and must stay in business. In terms of “which bank” to buy, it really doesn’t matter; put all four in your portfolio.

Engineering companies and infrastructure funds. They will benefit from the post-slump “pump priming” which governments will do to re-start the economy – just as happened after the biggest investment slump of all time, the 1930s. Australian Infrastructure Fund, Leighton Holdings, United Group and Transfield are well positioned to win work from government road, bridge and port building plans.

Energy stocks. Whether it’s oil or coal, these companies will benefit from the enormous demand for electricity here and overseas. Woodside Petroleum, Santos and Bridge offer oil and gas exposure. Riversdale, Centennial and Whitehaven are the pick of the coal stocks.

However, don’t forget there is no reason to rush for this – remember that bears really do move slower. For investors, that means you have time on your side.

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