Strategies for a bear market

The history of bear markets shows they usually continue until just about everyone has given up hope and fled the scene.As long as people believe that the markets are about to come bouncing back, they will continue to buy in anticipation of that just-around-the-corner rebound. This can have the effect of maintaining unrealistically high prices, as we saw in the tech market.

It’s when investors become convinced that a quick recovery is not going to happen any time soon and stop buying that prices can move to more realistic lower levels. It’s at that stage that a base is formed for a new stock market rise.

Period of uncertainty
It’s hard to tell how far we are from that point but we’re getting closer. Right now we’ve moved into a period of uncertainty about where we go from here.

This has been intensified by the conflicting signals we’re getting from the economy. On the one hand, inflation is running at a much higher rate than anyone expected, in part because of the continued strength in natural gas prices.

On the other hand, consumer confidence continues to decline, lay-offs multiply, and the profit warnings from tech comnies and others intensify.

This creates a push-me/pull-you effect on central bankers, notably the U.S. Federal Reserve Board. Chairman Alan Greenspan has long regarded inflation as the number one economic threat, to be combatted at all costs. He must have been unsettled when the January numbers came in so high. On the other hand, he is extremely conscious of the impact of the slowdown on the U.S. economy and the still-lurking danger of a full-blown recession. For the record, he keeps saying that won’t happen, but privately he must be deeply worried.

All this leads to wild speculation about what the Fed will do next on the interest rate front. For most of January and early February, it was taken for granted that the Fed would cut rates still more. Then the inflation numbers came out and the prognosis changed – how could Greenspan cut in the face of such high CPI numbers?

Best strategies
The reality is that we are in the middle of a churning sea with no clear idea of where land is or when the storm will subside. The markets are changing direction on a dime, with every new rumour, earnings warning, or brokerage house projection. 

In these circumstances, investors are advised not to try to outguess the markets or to place bets on timing. Your best strategies now are:

1) Maintain a core position in defensive stocks and equity mutual funds. If you own good quality growth stocks or funds, hold them as long as they do not represent more than about a third of your total equity positions.

2) Do not add technology stocks or funds to your portfolio at this time even though the prices may seem attractive.

3) Avoid index funds, especially NASDAQ, because they provide no place to hide as markets fall.

4) Maintain at least 10 per cent in cash reserves, with at least 30 per cent of that money in U.S. dollars.

5) Hold at least 30 per cent of your portfolio in fixed-income securities, with short and medium-term bonds favoured.

6) If you do not own any dividend funds, consider adding one for a combination of current income and future growth potential.

Adapted from the Internet Wealth Builder, a weekly e-mail financial advisory published and edited by Gordon Pape.