Bear Markets - June/July 2022

As an investor, if we want to succeed in the share market, our first aim should be to minimize our losses. We all are worried about our investments especially when a bear market pulls in. This brings me to the importance of understanding a bear market. We should be able to anticipate it and take appropriate actions.
The current bear markets have put all our portfolios down by 30%. But it is never late to realize and minimize our losses.

What is a bear market?
A full-fledged bear market occurs when the Nifty 50 or S&P 500 declines 20% or more from its recent high. They occur infrequently. For example- 2020 Covid crash (40% percent), 2015-16 bear market (25% decline), 2008 (GFC) bear market (65% decline), Dot Com bubble (51% decline), 1929 Great Depression (90% decline).
It is related to investor pessimism towards the future of the economy, corporate profits and stock prices in general. Sometimes a bear market is a precursor to a recession. A recession is declared when there are two consecutive quarters of negative gross domestic product which is a broad measure of the economy. A recession is characterized by a declining stock market, decreasing consumer spending and increasing unemployment.

There are 4 stages of a bear-
Stage 1 – Recognition – Initially no one considers that a bear market is pulling in because treating every bad week as the bear’s arrival would not only shred one’s nerves but would cause poor performance, should the investor act upon that instinct. Towards the end of this phase when markets start falling, investors begin to drop out of the markets and take in profits.
Stage 2 – Panic – In this phase, stock prices begin to fall sharply and trading activity begins to drop. The economic indicators start to become below average. Some investors begin to panic as sentiment starts to fall. This is referred to as capitulation.
Stage 3 – Stabilization – In this phase, the stocks halt their decline, thus creating an impression that will no longer fall. This subsides the panic but the situation remains grim. This period is marked by volatility. Sometimes, stocks rally furiously, only to be knocked back down. Investor sentiment varies between optimism and false hopes. This is also considered to be the bear market’s longest period.
Stage 4 – Anticipation – It is very difficult to predict the end of a bear market. This phase is characterised by stocks starting their recovery. This happens because of investors optimistic approach towards the growth of the economy as a whole. They make their bids, and stocks begin to rise.

What are the reasons for the current bear market?
During the Covid pandemic, people lost their jobs and businesses were hit. The economy had come to a halt when the world was hit by Covid. The Central banks try to create jobs and boost the economy by using quantitative easing. In quantitative easing, the central banks buy long-term securities from the market in order to increase the money supply and encourage lending and investment. This in turn lowers the interest rates and provides banks with more liquidity. When interest rates go down, it becomes cheaper to borrow money and people and companies will take more loans. Their increased spending will fuel the economy and create jobs. This was done to infuse liquidity. For example, the rates in the US were down to close to 0%. Since the return on fixed income assets was close to 0%, people started putting their money into equities. With things normalizing and inflation reaching its peak in the US, the US Fed is increasing the interest rates as a measure to control inflation. This has directly led the 10-year bond yield to jump up along with the US Dollar index. Higher bond yields and a rising US Dollar Index are both negative signs for the Indian markets

Hedge Fund Veteran Cooperman has predicted the US economy will tumble into a recession in 2023. He predicts a total of 40% fall.
Goldman Sachs expects an additional 200 basis points of fed rates hike in 2022. They have predicted the inflation rate to be at 6.50% for the US economy for the fiscal year 23.

Another reason for this bear run is the dollar index.
The US dollar is at an all-time high. The US dollar index compares the value of the dollar to a basket of 6 world currencies- Euro, Swiss Franc, Japanese Yen, Canadian Dollar, British Pound and Swedish Krona. The index has a base value of 100 and its value is a good indicator of the value of the dollar in global markets. The INR is not included in this basket but as the dollar index rises, the INR declines in value against the USD and vice versa. When the dollar index weakens, the rupee rises against the USD and when the rupee rises against the USD, the Foreign Institutional Investors (FIIs) get better returns on their dollar investments and vice versa.

For example, an FII named Morgan invests $10000 in India when $1= ₹70 making it an investment of ₹700000 in India. After a few months if $1= ₹80, then the investment value of FII in dollar terms is down by 12.5%. This is why when the dollar index rises, FIIs invest less in India because they expect lower dollar returns. On the other hand, when the dollar index falls, FIIs invest more in Indian markets. That is why during COVID when the dollar index was considerably lower in value, FIIs inflow into Indian markets increased and we saw a boom in the IT sector. But as the situation improved and the dollar started rising, we witnessed a heavy outflow from FII’s adding to the falling markets.

Why should you stay in cash in a bear market?
Different types of people follow different perspectives. Warren Buffett said that “They should try to be fearful when others are greedy and greedy only when others are fearful” in Berkshire Hathaway’s 2004 Chairman’s letter to the board. He believes in looking for value during bad times and trusting that things are going to turn around again.
According to some people, it is wise to buy stocks during a bear market because they are cheap. This notion stems from a recovery bias where they saw the Covid crash that lasted only one month.
However, in general, bear markets can go on for years. We can never predict the bottom of a bear run. When we buy a stock in a bear market, we do not know when the bear market will end. Most stocks can fall more than 50%.

Here is a numerical example to prove why we should not hold or buy stocks in a bear run:-
Investor A believes it is very difficult to time the market, so he buys and holds. He started investing in 2004 with ₹10000. His investment appreciated to ₹50000. In the bear markets of 2008- 2009, his investments were down 70 % and came down to ₹15000. In the following bull market of 2009, he doubled his investment to ₹30000.
He made a CAGR of 17% over the span of 7 years.
On the other hand, investor B is a momentum investor who sells his stocks and goes to cash whenever a bear market arrives. He started investing in 2004 with ₹10000.  His investment appreciated to ₹50000. In the bear markets of 2008- 2009, he got early signs and sold his stocks after losing 20% in the process. His investments came down to ₹40000. In the following bull market of 2009, he doubled his investment to ₹80000.
He made a CAGR of 35% over the span of 7 years
Hence, it is proved that loss works exponentially. If you let your losses run to 50%, you will need gains of 100% to break even. As retail investors, our aim should be to minimise our losses by cutting it short and protecting our capital.

Where can we put our money during a bear market?
We should think of safe havens during these times. Short-term Bonds and commodities like gold and silver are traditional places where investors put their money to keep their investments safe during times of turmoil in the financial market. There is an inverse relation between gold and equity markets. As equity markets fall, the value of gold increases. This is because people sell off their positions in the equity market and go back to traditional investing in Gold as they have trust in it.
Investors also start putting their money in real estate as it is considered a very good alternative during falling markets. Their value can go down but they are considered to be less volatile. Treasury bonds and fixed deposits are alternative ways to manage risk during times of panic.

We can also invest in companies which will benefit from a recession. For example, during a recession when people have less money, they will go to discounted stores like Walmart. Hence, companies like Walmart will perform well even in trying times.
High dividend-paying stocks and preference shares are some alternatives if an investor does not want to take out their money from financial markets.

We should remember that it is a global market and we can invest in economies that are performing well.