Why to Invest in Bear Market? How to go about it?

A true stock investor must always be prepared to invest in bear market. 

For stock investors, it is the bear market than makes chunk of their profits. 

Majority hate bear market. Bear market can cause huge losses for investors.

But people who accumulate only fundamentally strong stocks do not fear bear market.

For such people bear market is like a BIG opportunity.

Value investors (like Buffett) treat bear market as a time to grab quality stocks.

We may not see many smiling face in bear market. But value investors treat bear market as a Gods-gift.

Why?

Value investors loves to see stock market falling.

When others are fleeing market like cats and dogs, value investors stay glued to the stock market. Why?

Because they know how to use bear market to their advantage.

It is also true that investing during bear market phase  is like playing with fire. If actions are not taken prudently, losses can be huge.

Value investors are specially trained to take advantage of the bear market. We can also learn this skill.

Learning to invest in bear market is easy.

Focus should be to buy only fundamentally strong stocks in bear market phase.

These are such stocks available which are meant to be held for life-time.

No matter when bear market strikes, fundamentally strong stocks shall never be sold. Instead, more of such stocks should be purchased.

Every time the bear market returns, fundamentally strong stocks should be accumulated in bulk.

In this article we will see ‘why’ to invest in bear market, and ‘how’ to invest in bear market.

There is a strong hint that the next bear market in India is not far. Since Feb’18, the Sensex has dropped by almost 2300 points (6%).

What is bear market?

Bear market brings tough-times for any company.

Even though company’s fundamentals are as strong as before, market price of stock still fall drastically.

As my general rule, when index falls in a short span of time, by 10% or more, it can be termed as bear market.

In bear market, why price of even fundamentally strong stocks fall?

In bear market the environment is of pessimism. There are more seller of stocks than its buyers.

Majority sell their holdings whenever index falls so heavily.

Selling of stocks is almost like a reflex action in bear market. Extensive selling of stocks makes the market to fall to even to lower levels.

In year 2008, SENSEX fell from 20,000 to 8,500 levels (down 57%).

But does it mean that companies were doing bad business during that time?

Stock index touching rock bottom levels are often not due to bad fundamentals of the company. They are more due to a sense of panic and pessimism prevailing around the market.

What triggers such panic behaviour?

It has roots mainly into global economic conditions. In 2008, stock market collapse was linked to Banks in United States.

But the ill effect of it was experiences also in India (all over the world).

It is important for us to understand that stock market collapse does not necessarily mean company is doing bad.

Due to external factors, price of stock fall during bear market.

If fundamentals of company is strong, its market price will recover its lost levels.

This is the reason why it is advocated that buying stocks of fundamentally strong companies, during bear market is a good idea.

Why people start selling stocks in bear market?

Generally, people buy and sell stocks based on others advice.

They know nothing about the companies fundamentals, but they still buy its stocks.

As a result, when index falls stock-selling happens in sheer panic.

During such times of crisis, an informed investor does the opposite.

For him the moment is not of panic, it is of euphoria.

If a company is fundamentally strong, and its market price is falling, one must grab more of its stocks instead of selling it.

Buying gold at Rs 30,000/10gm is better or at Rs 25,000/10gm?

The answer is simple, because we have a feeling about the true value of gold.

A person who has not tracked gold movements in past, for him both Rs.25,000 & Rs.30,000 price levels are same. Why?

Because he is ignorant.

It is similar with stocks. It is important for investors to know which stocks are better and which can be avoided.

In stock investing, simply tracking historical price levels will not help.

Knowledge about companies fundamentals is necessary.

Expert investors will not even switch investment during bear market..

There are people who switch investment during bear phase (from stocks to debt linked instruments).

Expert who know to deal with bear phase, will never do it with their holdings.

So who we must behave when next bear market arrives?

  • Make sure you hold only fundamentally strong stocks.
  • Do not sell such stocks.

Long term returns of fundamentally strong stocks will be high.

So short term price corrections and bear markets does not bother such stocks.

Temporarily their price may fall, but it will get back to newer heights which situation normalises.

How to treat those stock whose fundamentals are not good?

There can be a case where one purchased stocks which were fundamentally strong then.

But today their fundamentals has become weaker (Like Banking stocks).

Even such stocks should not be sold in bear market.

Thumb rule says, sell your holdings when other are willing to buy it. Such situation will come only during bull market.

So, if at all experts have to sell stocks like Banking stocks, they will wait for the market to recover.

How to make money in bear market?

One can make more money in bear market than in bull market.

Everyone loves bull market because investing is easy in those times. Skill is required to invest during bear phases.

What skill is necessary:

If one can develop both, then he/she can invest in bear market and make phenomenal amounts of money.

Bull market is more for short term traders.

But bear market is useful for long term investors. How?

Suppose, a stock generally trades at Rs.100 levels.

In bear market conditions its price falls to Rs 65 levels. In this condition a knowledgable investor will buy this stock.

Without any effort investor will get price advantage of 35%.

When market condition improves, there is a high probability to see at least 20-25% upward trend.

In stock investing, price appreciation of 20-22% is considered excellent.

If one is holding a blue chip stocks (fundamentally super power), he will also get another advantage. Blue chip stocks also pay consistent dividends.

In normal times dividend yield of blue chip stocks are very low.

When such stocks are purchased during bear phase, dividend yield of blue chip stocks improves dramatically.

Dividend earning is another motivation why people invest in bear market. Bear market allow investors to grab high dividend yielding stocks.

Bull vs Bear Market

In bull market, investor generate small returns (5-8%) due to price momentum.

But investing in bear market can easily give returns > 18-20%.

One can maximise returns if one can invest when the index has bottomed.

But this is also true that it is not easy to identify market bottom.

But starting to invest when market has bottomed is not the real issue.

The crux of the matter is to avoid buying stocks when market is at peak.

When investors invest in a bear market, it is certain that stocks are getting picked at their peaks.

Why common men generally lose money in stock market?

Because he enters the market at the point where market has already peaked.

If one can follow a simple advice, making money in bear market will be a piece of cake.

Start to buy stocks as soon as index fall by 20%. Henceforth, every time, index falls by another 5%, buy more.

This buying spree shall continue till index keeps falling every 5%.

Its also easy to invest in bear market.

But still people love only bull phases. Why?

People feel happy when they see stock market going up.

They only know one concept of making money from stocks market, “buy low and sell high”.

They are not wrong, but what they miss here is the following two more concepts of stock investing:

  1. Buy stocks of good business.
  2. Buy them at undervalued price levels.

If one can implement the above rules, and then apply the “buy low and sell high” logic, money making is confirmed.

How to identify the next bear market?

How to if the bear market is arriving so that one can be prepared for investing?

There is no exact quantification of bear market.

In normal days, stock market correction of +/- 2% is not surprising.

But when index steadily falls week after week, this must raise few eyebrows.

To identify bear market, track BSE 500 index on weekly basis.

If index falls by 5%-6% in a matter of few weeks, it hints at the arrival of the next bear market.

[Example: On 23rd Jan’18 S&P BSE 500 was at 15,600 levels. Today S&P BSE 500 is at 14,500 levels. This is a fall of 7% in a matter of 6 weeks.]

Even better will be to track performance of top 5 market cap stocks.

If price of these stocks has also fell by 5%-6% then it means that the next bear market is possible around the corner.

Example:

Index / StocksJan-23-2018Mar-15-2018Price Fall during this period
S&P BSE 50015,60014,5007.05%
RIL9819156.73%
TCS310328767.32%
HDFC Bank195118853.38%
ITC2762663.62%
HUL136613044.54%
Average5.44%

One can also look at the Price Earnings Ratio (P/E) of the Index (like Sensex).

Example:

on 15/Feb/2008 average PE ratio of BSE was 17.35.

If in next 30 days the P/E ratio of Sensex fell to 13 (fall > 20%).

This is again a confirmation of bear market arrival.

It is not easy to know when is the next bear market.

But when bear market is arriving and is also closer, it starts giving hints.

But it must also be kept in mind that bear market does not happen very often. They are not likely to happen every 5 years.

Acceptable cycle after which one can expect a bear market (or at least a major price correction) is after a span of 8-10 yeats.

Complicated socio-economic factors give rise to a situation which triggers bear market.

My suggestion is to control your nerves. Go on accumulating savings. Start a recurring deposit in bank.

Do not invest in stock market in normal times and exhaust your savings.

Wait for the bear market to arrive.

When bear market actually arrives, break your recurring deposit and buy fundamentally strong stocks.

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