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How to prepare for a bear market

For those unwilling to wait for the detailed analysis outlining the necessary strategy, I will save them the time and provide the answer immediately – you cannot prepare for a bull market because it is nearly impossible to know when it is coming. Whilst I liken the skill of market forecasting to that of palm reading, there is no shortage of those prepared to have a go and reassure you their analysis is fool proof.

The problem with subscribing to market forecasting is that you are forced to make a decision, either to ride it out or act decisively.

In order to successfully negotiate a bear market (assuming dramatic action was required) I would suggest it requires more than just the ability to predict the bear market. Assuming one was capable of doing that, you would then need to perform the following:

  1. Figure out how this will impact individual stocks

  2. Don’t exit too early so that you forgo gains which potentially outweigh losses you avoid

  3. Display sufficient mental agility and nerve to buy once your prediction has become a reality

  4. Be fully invested so you don’t miss the recovery

The reality is that no one has been able to demonstrate that they have the ability to successfully forecast market downturns consistently. Bull markets don’t come with a time limit so ignore comments that begin with “Action required as bull market enters late stages”. Bull markets often end as a result of an event rather than a timeframe, more often than not it’s rising interest rates. It is inevitable that a bear market will occur at some stage in the future however it can be especially costly if your preparations for this event see you exit too early.

Peter Lynch, the famous investor, once said the following:

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections than has been lost in corrections themselves” – Peter Lynch

Market timing is often one of the largest detractors from long term performance as can be seen in the chart below:

The returns demonstrated in the chart above show the average investor usually achieves a return worse than any of the underlying asset classes, which could only be as a result of being invested in the asset at the wrong time. Just choosing any one of the underlying assets and doing nothing, would have achieved a better result than the one the average investor has achieved, through a combination of the above or applying some sort of tactical allocation.

Market forecasters are part of this problem as investors are often emotional in their decision making, and it is only human nature to take action in order to avoid potential pain. If a “market expert” tells you there is a sell off imminent, it seems logical one might want to exit the market; however if that advice came with a disclaimer that the forecast is only successful one out of every 10 times, the forecast may be treated (quite rightly) with a healthy dose of scepticism. It is not good enough to say a bear market is coming as we all know that, if it arrives in 5 years’ time and the market has doubled in that period, the cost of sitting on the side-line could be far greater.

We accept there are aspects of investing beyond our control and that we cannot predict all outcomes, it is our responsibility to allocate capital based on what we know. Our approach as always, places a strong emphasis on investing in quality businesses with high returns on invested capital, strong cash generation and growth opportunities to reinvest at high rates of return.

We prefer to focus on the facts and do not rely on special information or unique insights but most importantly our approach is structured and must be repeatable. On top of all of this we believe a healthy dose of common sense is required before subscribing to tales of doom.


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