Will the upcoming US election cause a significant market correction?
I would describe the current market as being jittery. There are concerns that the upcoming US election will be the catalyst for the next market crash, particularly if it is Biden for the win.
Why so? The market is concerned that Trump will refute the election result and refuse to concede defeat. That will raise a whole lot of uncertainty, something which will definitely spook the market.
In the event of a severe market correction resulting from election uncertainties, the question begets: How to prepare for a bear market?
Even if the current US election is not the catalyst for a major market correction, a bear market will happen sooner or later. Knowing what to do in such a scenario is critical.
The first thing you should NOT do is to panic when you see your portfolio value plunge. It is human nature to get emotional and often that emotion gets the better of him/her in a steep market correction, resulting in actions that lead to regret. Instead, take a deep breath, tune away from the market, and follow the 3-steps game plan outlined below.
3-steps Game Plan
Step 1: Review your portfolio to see if a rebalancing is in order
Step 2: Stay the course but look to reduce exposure to low-quality stocks
Step 3: Have your “shopping list” ready
Let’s go through each step in more detail.
Step 1: Review your portfolio to see if a rebalancing is in order
Take a hard look at your portfolio. Is your portfolio well-diversified across different asset classes and geography? If your portfolio is well diversified heading into this recession, you are likely in a much better position than most and there is nothing to panic about.
Look at rebalancing your portfolio. If you are holding a mixture of stocks and bonds, you might consider selling some of your bonds which will likely gain in value as fund flows into safe-havens amid market uncertainty and using those proceeds to reinvest in stocks. By rebalancing your portfolio periodically, you avoid substantial exposure to certain asset classes.
Rebalancing on a DIY basis can be done in two ways:
- Sell some of one investment and use the proceeds to buy some of the other investments as detailed above. If your bonds have done better, this will mean taking profits on some of your bond holdings and using the money to invest in your stock fund. This is a “Sell High, Buy Low” re-balancing strategy that when done repeatedly, should result in a better overall portfolio performance compared to one without rebalancing.
- Use new money that you are investing to re-balance your portfolio back to your target weightings. This will mean investing more into the asset class that has “declined in value” relative to your other investment class.
After an 11-year bull run, most investors without a proper portfolio rebalancing plan might, however, find themselves significantly exposed to stocks. If you are uncomfortable with being overweight to stocks at present due to election uncertainties, you can consider rebalancing your portfolio into other asset classes.
I do not recommend bonds at present due to the already low-interest-rate environment. Nonetheless, bond values can still increase amid global uncertainties as well as the push towards a negative interest rate environment.
However, my preferred asset class will be Gold as well as some bitcoin exposure. I have written about Gold as an inflation hedge numerous times and while inflation concerns currently are still benign, don’t be caught flat-footed with a sudden spike in inflation as a result of incessant money-printing activities as well as natural disasters, the latter already translating to food inflation of late.
Bitcoin is getting a bit of a resurgence of late. In the latest turn of event, JP Morgan joins in the party with its own cryptocurrency JPM Coin. For years, JPM was skeptical of Bitcoin, with its CEO Jamie Dimon publicly commenting back in 2017 that Bitcoin was a fraud. In a subsequent interview with CNBC, Mr. Dimon said he regretted calling Bitcoin a fraud and highlighted that the blockchain technology is real.
Reputable organizations such as Square, PayPal, and recently our very own DBS Bank are jumping onto the bitcoin bandwagon.
Well, I guess that leaves Warren Buffett still not at the party.
Step 2: Stay the course but look to reduce exposure to low-quality stocks
If you are vested in a portfolio consisting of ETFs which in itself is a diversified basket of stocks, this step might not be very relevant to you. All you have to do is to continue staying the course and engage a dollar-cost averaging (DCA) approach to buying INTO the downturn.
I recently chanced upon an interesting website called The Measure of a Plan. It has an interesting market timing simulator. This tool allows you to compare the performance of two investing strategies:
#1: investing in the stock market in a regular monthly cadence — regardless of the current market price
#2: ‘timing’ the market by keeping your savings in cash and delaying your entries into the stock market until the price is ‘low’ (for example 5%, 10%, or 20% below the all-time high price)
Does the route to riches rely on time in the market or timing the market?
Well, you would have guessed that the evidence likely points favorably towards “time in the market” vs. “timing the market”.
For those who invest in individual stocks, take this opportunity to relook at your stock portfolio, and reduce your exposure to low-quality stocks. These are stocks that are unlikely to survive the next economic downturn, characterized by a high level of debt and insufficient cash flow generation.
Some of these stocks are already seen as “zombie” stocks. Stocks that struggle to perform well during good times. What is going to happen to them when the going gets tough?
Instead of praying for a miracle, bite the bitter pill and cut your losses while there is still “value” in these stocks. The capital from the sale of these low-quality stocks can be re-deployed opportunistically in beaten-down high-quality counters.
This will be highlighted in Step 3.
Step 3: Have your “Shopping” list ready
As Warren Buffett famously coined: “Be Greedy when others are fearful”, a market downturn provides the best opportunity to buy into high-quality counters at a discount.
Instead of following the masses who are gripped with fear, look to deploy capital into beaten-down high-quality blue-chip stocks selling at a discount. This might mean having ready “cash on hand” to double down on such opportunities or as I previously mentioned, selling zombie stocks to reinvest your capital into fantastic companies trading at a discount, those that have a much higher probability of surviving a prolonged economic downturn in one piece, or even emerge stronger out of the crisis as they take market share away from their debt-laden peers.
Make a “shopping” list of your stocks that you always like to own but hesitated due to their valuation. A “crisis” driven NOT by the deteriorating company fundamentals but more by the broader market sentiments (such as election uncertainty) is an opportunity not to be missed.
“Never let a good crisis go to waste”, popularized by former White House Chief of Staff and Chicago mayor Rahm Emanuel who famously said it during the Great Financial Crisis, one should look beyond the current loss of portfolio value and take advantage of good companies selling at a discount.
Conclusion
Everyone looks like an investment guru during bull markets but when times get tough, self-doubt and ill-advised tactics can take root and harm your portfolio. Even the most confident investor can fall victim to harmful short-term thinking. For example, panic-selling your entire investment, speculating on penny stocks for that BIG win, or staying glued to your portfolio every day. These are all harmful actions that one should not take in a market downturn.
Follow the 3-step process as outlined in this article and you will likely weather the market downturn just fine. Stay the course and ignore the day-to-day noises that will just serve to cloud your better judgment and turn you into an emotional freak.
Know that with a good plan in place, a market correction or downturn is more of an opportunity than a risk. However, with that said, don’t spend all your time on the side-line praying for the next major market downturn to deploy your capital.
That day might never happen, with trump or no trump.
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1 thought on “How to prepare for a bear market. A simple 3-steps process”
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