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To make money in a bear market you can either short stocks and profit when they go down, buy inverse ETFs, or move into markets that do well when the stock market is down, like gold. In this guide we will explain what a bear market is, what opportunities they hold for investors and give some strategy for investing when in  a bear market.

What is a bear market?

A bear market is a general term that describes falling prices over a period of time. Some market commentators stick to the definition that when major stock indices have fallen 20% from their highs, it signals that a bear market has commenced.

Like night follows day, a bear market often follows from a bull market. This is to eliminate the excesses accumulated during the bull market. The last bear market we saw was in March 2020 when the pandemic took hold. But are we in a bear market now?

Today in the U.S. we are in the fourth super bubble of the last hundred years.” declared market expert Jeremy Grantham in his widely-read market letter, entitled “Let the Wild Rumpus Begin“.

The most important and hardest to define quality of a late-stage bubble is in the touchy-feely characteristic of crazy investor behavior. But in the last two and a half years there can surely be no doubt that we have seen crazy investor behavior in spades – more even than in 2000 – especially in meme stocks and in EV-related stocks, in cryptocurrencies, and in NFTs.

After seeing a late-stage massive blowoff a few years ago (see below), he concluded that “this checklist for a superbubble running through its phases is now complete and the wild rumpus can begin at any time.”

Source: GMO

How to invest in a bear market

There are a few strategies to use during a bear market.

1. Overweight cash (and wait for opportunities)

One of the most undervalued assets during a booming market is cash. Who wants to hold cash when asset prices are leaping? What is missing in this logic is that markets can turn around quickly and trap investors who bought at high prices. You don’t see Buffett going ‘all in’ with their cash holdings.

In a bear market, cash is king. It gives investors the most flexibility in buying stocks at the most favourable prices. This lays the foundation of bagging a fortune in the ensuing upswing. As the saying goes, “you make most of your money in a bear market; you just don’t realize it at the time.” (S. Davis)

2. Buy (very) oversold conditions

During a bear market, prices can plunge suddenly and overshoot to the downside – due to a cascade of bearish catalysts. In these instances, you can trade the depressed sentiment by buying sound companies that are temporarily oversold. This strategy works for quality companies – not crazily overhyped ‘stonks’.

But because you will never know in advance whether the bear market has ended, so scaled in gently with an appropriate position size relative to your portfolio and utilise stop losses. Once prices move advantageously, take the profit and don’t be greedy. Wait for the next opportunity. Enforce some trading discipline.

Bear market rallies can occur once or twice in a year. Depending on sectors, some stocks can bounce 25-100% over a short period of time.

3. ‘Know what you own and why you own it’ – P. Lynch

The bear market will likely annihilate the most vulnerable companies – companies with no viable income, market share, or products. They will suffer during a recession, however mild. Knowing a sector inside out becomes an edge. This edge differs from person to person. One might be an expert in online retail sector; the other auto industry. Having an edge gives investors the courage to hold a stock during a market setback.

Companies most likely survive a recession are strong companies with a sticky ecosystem, with good product streams. These companies often rebound the fastest due to investor accumulation.

Once you know a company thoroughly and have faith in its long-term prospect, buy on setbacks and wait patiently for the better times to return.

4. Look for new leaders

Every cycle brings out new stock leaders. For example, many high-flying Nifty-Fifty stocks collapsed during the 1974 bear market and never recovered. Many dot-com stocks went ballistic in the late nineties. But by 2002 many were gone and liquidated.

The seeds of the next bull market are sowed during a bear market.

The key question is: How do we detect new cycle leaders? Relative strength (see GMG Guide on Relative Strength). This measures the price of the stock relative to the price of the market, say, the FTSE 100 Index. Stocks that exhibit good relative means it is outperforming the market – and market leaders outperform the market.

Remember Tesla’s (TSLA) stunning advance in 2020 when the world was still mired in the pandemic? That’s relative strength. Tesla’s share prices broke new all-time highs in June 2020 and then promptly rose 5x in six months!

To differentiate your portfolio from the rest, always look for potential new leaders in the next bull market.

5. Overweight safe-haven assets like gold

Gold has been surprisingly resilient these days. In other words, it is exhibiting ‘relative strength’.

A quick look at gold’s chart confirms this. Prices have retracted its earlier losses and are approaching the psychological $2,000 ceiling again.

Why is gold favoured? I can surmise a few reasons. But the key is this: Few assets are better than gold at this point.

Just to compare asset classes: Stocks – may drop further; Bonds and property – interest rate rises will ensure another down leg; energy – a looming recession will cause prices to skid; and Bitcoin – too volatile.

Therefore, the wealthy may see gold as a ‘safe haven’.

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