If this is a newly born bear market this article shows how to deal with it
Istanbul has me now
Actually it doesn’t any longer, since I got back from Istanbul today (Sunday, October 4).
During my four nights there, I was asked in an e-mail whether I thought the downturn on the stock markets would be “smooth like in 2008” or exhibit a “small bounce by 10% now”.
True to form, I immediately replied I thought the current downturn probably will be interspersed by at least a dozen dead cat bounces of 10-15% each, just like during the last two bear markets.
You can take my word for it that’s how it usually plays out.
On the other hand, then you’d be taking this guy’s word, which might not be wholly recommendable…:
Table surfing in Istanbul
Bear market bounces, a.k.a. bull traps
Instead of trusting Mr Surfer above, check out these two charts, where I’ve highlighted bounces of approximately 10% or more.
If intraday data is counted, there are several more bounces. The following, however, is enough support for the thesis that you should expect much more than just a handful of large bounces during a short cyclical bear market:
Don’t worry about the US centric choice of charts. E.g., the Swedish OMX index exhibits the same pattern. The same goes for downturns in general. No matter differences in economic exposure, valuation levels etc.; where the S&P goes, the OMX goes too.
How to trade a cyclical bear
First, you have to decide whether you think a bear market is in the works or not.
I think the bear market has started, for several reasons: The bull market was getting long in the tooth, valuations are ridiculously high, market dispersion has increased, key moving averages were broken decisively during the drop in August, other markets have already signaled distress (oil, e.g.).
You may not agree. If not; as you were.
Second, should you care at all? If you strictly adhere to the “Buy and Hold” investment strategy, the answer is no. Just don’t change your mind any later than now. Actually, even a BAH investor can benefit from a road map for timing stock purchases, so keep reading.
Third, if you do care, if you want to trade the bear, do you want to make money shorting, or just try to time a large purchase close to the trough?
I’m not recommending anything here, I’m just asking you to analyze yourself, and make a game plan before things heat up. Bear markets are not child’s play and it’s easy to lose one’s religion during market routs.
Regarding buying at the bottom, you won’t know when it’s time, just as nobody rang a bell at the top. However, if you start buying once the expected annual return exceeds 10%, and then accelerate your purchases when market dispersion falls (trend uniformity increases) and junk bond yields fall significantly, you should come close enough.
There are too many ways the bottoming process could play out for me to detail them all here, but no matter what happens, just focus on buying ‘cheap enough’ and make sure you get the risk aversion trend with you before going all in.
Aggressive bear trading
I will trade the bear much more aggressively than most. I plan to do it in a way I couldn’t recommend anybody.
To start with, 75% of my active portfolio consists of XACT BEAR (which is a Swedish stock index ETF with a negative delta of 1.5). Hence, more than 100% of my portfolio’s net value is short. The rest, around 25% is invested in gold. I also have all but negligible amounts invested in a couple of single stocks and cash earmarked for oil.
I plan to reduce my short position whenever stocks drop by 20% (from a recent peak or with a sudden new, steeper, trajectory), like in Q1 2001, September 2001, summer and fall of 2002, October and November 2008, as well as March 2009.
Then I’ll increase my shorts again, after a bounce by more than 10%, and even more if the bounce grows to 20%, like in the second and third quarters of 2001.
Once the total drop amounts to around 50-60%, I’ll focus more on reducing my shorts after sudden plunges than putting them back on again after bounces and surges.
However, my main indicators for when to start going long in earnest, are market dispersion (industry, Advance/Decline, new highs/lows, etc.), dropping junk bond spreads, various sales multiples (P/S, Mcap/GDP etc.) and long moving averages.
Given that markets don’t just revert to the mean, but invert the overshooting to undershooting below the mean (unless the average has shifted upward permanently), the current downturn could be even more vicious than even I expect. Nevertheless, if I can buy stocks on multiples promising 10%+ annual returns, I will (fully knowing there could be another halving waiting before the ultimate trough). The above factors, as well as time, will guide me.
I have a feeling this cyclical bear, the third and last during the 18-20 year secular bear that started in March 2000, will be extraordinary. I’m just not sure how. It could be unusually large reductions in value from peak to trough, it could be the number of bounces, the intensity of plunges and bounces (due to e.g. higher lending, more derivatives and much more and larger HFT accounts), or a more prolonged process, e.g. Or all of the above.
Anatomy of this bear
What follows is my current game plan for the current cyclical bear.
Peak: summer 2015
Trough: between July 2017 and July 2018
Total drop in value: -60% for S&P 500 to 850
# Dead cat bounces >10%: 15
Just as during the previous two cyclical bears, I think we’ll see progressively bigger drops, followed by correspondingly bigger bounces, until both the plunges and bounces moderate (like between September 2002 and March 2003) after a capitulation event like the one in June, July 2002. That kind of bottoming out process is likely to take place between the summer of 2017 and the summer of 2018, i.e. 2-3 years after the peak.
I think the Fed will feel forced to try a rate hike sooner or later. Perhaps to signal all is okay. Then they’ll backtrack due to a market plunge (that I plan to buy on, i.e., temporarily reduce my short positions) and launch a new QE program (#4).
I think the USD will strengthen during the market plunge, the flight to safety effect helped by the interest rate hike. I also think China will devalue its currency aggressively, intensifying the currency wars. That in turn will propel real assets upward: gold, bitcoin and oil (though the latter needs to get low enough first).
I plan to buy oil again once it starts falling in tandem with weaker macro data.
I have enough gold… I think.
End game
High margin debt, and losses on derivatives will pressure stocks in a vicious circle of liquidation, culminating in a final death spasm, sending markets down a final 25% in a single quarter with revenue based valuations reaching typical bear market levels.
Very few will have the guts or the cash to buy stocks by then. I hope to be one of them.
If you held on to your stocks throughout the bear, they probably lost 60-70% in value over 2-3 years, but you can of course still buy more for whatever cash flow you produce. Let’s just hope your job is secure, interest rates or rents haven’t risen too much, or you’ve lost your faith in stock markets by then.
Conclusions
The bear is here
Decide whether to sell, or just buy (I have already sold)
Whatever you take away from this article, just remember the recurring pretty large bounces.
I don’t intend to try to time them perfectly, that’s impossible. However, I’ll still buy on dips and sell on surges and hope to make a little extra even if I sometimes miss out completely.
Also note that the plunges become larger and larger as the bear progresses.
Bear markets almost seem constructed to cause the maximum amount of pain for long-onlies and newbies.
Most of all, prepare a list of things to buy when (if) they get cheap enough. Start building the list right away – either alone, or with a group of trusted friends (or on the line for that matter).
Remember that the return of any investment should be positive for you, not just your bank account. If certain investments or investment decisions keep you awake at night for long periods of time, it’s just not worth it. You are supposed to manage your resource allocations in a way that adds value to your life.
Sign up for my (weekly-ish) newsletter, and I’ll keep you posted on my personal investment choices. Don’t expect a high trading style turnover rate, but perhaps a few well timed decisions taken with a bird’s eye view of the markets. Tell a friend too.
Always be investing – this is how I interpreted my own advice when hungover in Istanbul (4 days in a row with the same 40 in 40)
If you can’t control your finances or investments, at least you can control your body. That’s where your life begins, and that’s where it ends. The rest is just noise.
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”That in turn will propel real assets upward: gold, bitcoin and oil”
Interesting.
What’s your take on bitcoin, Micke?
b.t.w., looks like you had some fun in Istanbul. :)
Maybe one day you tell me how you manage to drink as much, as you seemingly do, and still stay in shape.
Expert in hangover weight lifting, right? ;)
But I do know the truth, you’re in great shape because you drink. ;)
Bitcoin: similar to gold, i.e., worthless but practical for various reasons.
I’m sure cryptocurrencies will be a big thing, many of them. Bitcoin might be one of a million different cryptocurrencies, one better and more advanced than the other. Bitcoing might be what PacMan is to [insert whatever computer game people are into these days].
How to manage drinking and staying fit? I have an easy 2-step formula for that:
1) drink a lot
2) stay fit
Thanks for your view on bitcoin, Micke, appreciate your quick reply.
Judging from the current developments in terms of cryptocurrencies, you seem to be spot on.
”How to manage drinking and staying fit? I have an easy 2-step formula for that:
1) drink a lot
2) stay fit”
lol, you’re funny guy in my book. :D
Next up on MikaelSyding.com:
How to be a Hedge Fund Manager and a Bodybuilder?
Easy 2 step formula:
1.Be a Hedge Fund Manager.
2.Be a Bodybuilder.
Done.
But hey, trolls gotta troll, right? ;)
Best part about it though is that there’s actually some truth to what you say. :)
Hallo,
What kind of gold are You byuing and how? Stock, funds or physical gold?
ETFs for now. GDX (senior miners) and GLD (gold). Check out my post on gold for more details.
Thanks för sharing your insights! Very interesting!
Also curious about your thoughts around investing in bitcoins in this bear market.
Thanks!
I think Bitcoins could make for an interesting vehicle for speculating on rising unrest in a downturn. I wouldn’t invest in BCs longer term.
This is a very pessimistic scenario. 2008 was not a smooth decline but a brutal crash, and so was the decline after year 2000. I think we have had to many crashes in a short period making us believe crashes are normal. Index is at same level as 15 years ago. What is your strategy with Xact Bear if you are wrong? Loose 75% of your capital?
Very few even remember the downturns before 2010…
To me that’s evident just by looking at the brutal surge since 2009. The last 20 years, markets have been marked not by crashes but by government induced bull runs, interspersed by corrections.
However, this article wasn’t about predicting a crash, it was about how a bear would play out if this is a bear.
If I’m wrong and keep being wrong, then, yes, those 75% will turn into 0. On the way up, however, I’m sure other evidence will present itself that makes me change my mind.
Like you said, bear markets are brutal. Personally, I’m not at all convinced there will be a crash. I think we can move sideways from here for a long time.
Since I’m not a trader, I’ll keep a lot of cash and slowly invest in individual stocks whenever the long term returns looks good enough. Good luck with the trading and thanks for sharing your thoughts!
To each his own.
And I have no reason for convincing anybody about the risk of a major correction. Sideways for a long time would be just as good.
What about buying during Mkt events, for example do you look at Volkswagen as a deal at 50% off or as something that is toxic?
If it’s cheap it’s cheap. Volkswagen def. looks interesting. All mfgs probably cheated anyway…
However, I don’t know anything about cars and car manufacturers, so I stay away from VW.
Thanks for sharing game plan, useful perspective. Not sure about gold though…looks rich at 25 x oil price (barrels per ounce), close to historic highs
Niklas! Everybody take notice. This is one of the sharpest guys I know.
He’s right of course. The gold/oil relationship is not appetizing at all. Perhaps focus on oil instead. Or wait for oil to rise before buying gold.
I’ll take my chances with gold anyway… Since I think oil is the anomaly here.
Great minds don’t always think exactly alike.
Hej en dum fråga men du skrev “expected annual return exceeds 10%”. Betyder det att man ska köpa när PE är under 10 eller vad är korrekt översättning?
Tack för en underbar blogg! Väldigt inspirerande! Lyssnar fortf på de avsnittet när du va med i Börssnack =)
Hej.
Tyvärr är det mer komplicerat än så.
Men, om du har en normaliserad vinst med normaliserad marginal, normaliserad omsättningsnivå, normaliserad tillväxt osv, dvs hittar ett perfekt representativt normalår, då kan du också använda ett bstämt P/E-tal som grund för om du ska köpa eller inte.
I praktiken funkar det bättre om du tar en P/S-multipel, men det funkar ofta sämre eller inte alls för enskilda företag (men bra för börsen som helhet på 8-15 års sikt). Jag får nog skriva en hel artikel, eller bok (är på gång) om ämnet för att bringa klarhet.
Tack för snabbt svar! Jag håller utkik efter den artikeln / boken!
Tack igen Micke!
any update view on the market?
since last month, markets up about 10% or so, and we’re now above the moving averages again and moving towards all time highs.
appreciate your view.
Impressive bounce.
Market breadth is still weak though, and several other indicators of risk tolerance are pointing toward a resumption of the downward trend.
Nobody knows of course; this is not about valuations, interest rates, profits or gdp but risk appetite and flows. In any case, this is not the place and time to take big risks; nobody became poor from not participating fully in the stock market for a year or two. Or ten. Actually most 18-year olds today have been out of the market for all of those 18 years, and most newborn will be out of the market the coming 18 years. They will still get their opportunities.
I think it’s going down, but if I’m wrong and indicators change, it was just foregone opportunity for some time. There is never any rush to participate in markets.
And I just caught this: http://www.theguardian.com/business/2015/oct/07/next-financial-crash-is-coming-imf-global-stability-report?CMP=share_btn_tw
Seems.. uhm.. good.. not, maybe I should just not buy for awhile and just save more cash.
It’s pretty amazing that after 6 years of bull market and recovery, interest rates are still at zero, and debts at historical all time high, right when the cycle is turning downward. That is terrible.
How should I as a layman (newb) look for acute signs that it’s going crashing (before it does, maybe not even possible)?
Also, thank you for your posts Mikael. They are eye opening! :)
Thank you
Acute signs are all related to risk aversion which shows up in widening yield spreads, in particular higher junk bond yields, in inter-sector dispersion (various stock sectors starting to perform very differently), waning market breadth (Advance/Decline ratios, % of stocks above 200d mva), asset class divergence (e.g. crashing oil [or gold])… etc…
Basically, signs that investors are not only any longer just buying anything lagging the slightest, thus causing dispersion instead of convergence. YOu can make up your own signs and back test them, with a little imagination
Alright, I’m not familiar with all of the concepts you provided but now I have something new to learn. Thank you! :)
Just keep a lookout for rising junk bond yields and stock prices and stock indices falling below 200 day moving average, as well as the ratio of stocks in an index being below their 200day moving averages. That takes you a long way.
appreciate your feedback.
i understand no one became poor by not participating in the rally, but remembered reading back to this article that 75% of your active portfolio was short the market with XACT BEAR and the rest vested in generally gold, which both have not done well.
i’m very short the market, but i feel like i put way too much in that the investments keep me up at night and by what you say take away value rather than contributing to life.
how do you recommend to your readers dividing total assets between active trading, cash, long term investing for someone in their early 30’s?
unfortunately, i have a bad habit when it comes to investments and trading. i see a bunch of cash in my trading account, and often go all in trades, rather than making certain allocations over time. this has resulted in very heavy losses, especially with margin when the timing if off.
on the another note, really appreciate your comments and blog. i’m amazed that someone with your past career and credentials takes the time to help provide insight to regular people out there.
I never reommend anybody going short or trying to time a market peak.
However, I do it myself since I want to be right and I think I am right, even if off by a year or two. It still is reckless speculation unless you have enough money.
Even if I lose 75% I’m still good. Everybody should position that way.
I think 0% should be allocated to active trading – it’s a waste of time (unless you enjoy it). The level of cash vs long term investments is more difficult. It varies with your age, your time horizon for spending, the market’s valuation/duration and thus can’t be pinpointed. Right now I would recommend 0-15% stocks (international, non-euphoric markets, stable large cap stocks but not the market leaders) and 85-100% cash or cash equivalents (gold, corporate bonds, money market instruments)
PS: We are all regular people. I just happened to make a lot of money
Out of curiosity regarding “Corporate bonds”, which ones would you recommend (that are available on Avanza?)
Best,
Nils
Unfortunately I haven’t researched them (yet).
Okay, thanks anyway! :)
I love your blog and life philosophy :-)
OMXS 30 is now down over 19% since the peak in April. Do you consider this close to a case of “I plan to reduce my short position whenever stocks drop by 20%”?
Keep up the good (fun) work
It’s close enough. I have increased my short (trading) by 4% and reduced it by 8% (trading and strategic. Consequently, I’m about 4% less short now, than when I wrote the article. Proceeding as planned.