To shrewd investors a ‘bear’ market is more than a drop in stock prices that may last close to a year. It’s also an excellent opportunity to buy stocks at attractive prices, as well as a good time to adjust the balance and diversification of your portfolio.
How bear markets create investment opportunities — if done correctly
Seasoned investors know that it pays to ignore one-week or even one-month drops in stock prices. They regard such moves as temporary fluctuations that have little bearing on what happens to stock prices in the long run.
It’s a different matter when price declines last for months, however. For instance, with fluctuations along the way, the S&P/TSX Composite Index has now dropped about 17 per cent from its all-time high above 22,213 in early April. Meanwhile, the S&P 500 in the U.S. is down 24 per cent from its all-time high of 4,819 in early January. Now wise investors are trying to determine how long this decline is apt to last — and how they can profit from it.
Our own view is that the current decline is a ‘bear’ market. Stock prices could go lower in the months ahead. But we expect they will resume their long rise in the not-too-distant future — perhaps sometime next year.
Much will depend on whether North America falls into a recession and how long it takes for central bank interest-rate increases to begin to bring inflation down in a meaningful way.
Use sound fundamentals
While we don’t pretend to know when the market bottom will be reached, we think that periods of lower prices present you with a good occasion to look for investment opportunities — especially those that will assist you in building or maintaining a healthy portfolio.
Choose your investments so that your portfolio has adequate representation in all of our main industry sectors. Generally, we feel you should keep 15 per cent to 25 per cent of your portfolio in each of five areas: banking and finance; utilities (or regulated or partly regulated companies such as telecommunications, pipelines and electrical utilities); consumer products and services; manufacturing; and resources (which include oils, mining, forest products and so on).
If you feel your portfolio is lacking in any of these areas, now’s the time to set aside funds to make purchases to correct the situation. You should also review your portfolio to see if you are over or under represented in any individual holding.
Over the years, we’ve found it’s generally best to limit each of your individual investments to about a minimum of five per cent and a maximum of 10 per cent of a full-sized stock portfolio. That way each holding will be large enough to make a significant difference to your portfolio. But it won’t be so large that a drop by just one stock will cause a serious setback in your total portfolio. That means you should aim to own about 20 to 25 stocks in your portfolio over time.
Eliminate poor performers
After you review all this, you may find you need to sell some of your holdings to improve balance or diversification. Of course, the natural tendency is to sell stocks that you own that have gone up since you bought them — those that will provide the biggest profits.
We feel you will do much better in the long run if you eliminate the poor performers first — especially those whose long-term earnings prospects have diminished since you bought them.
This will leave you with a stronger portfolio, which is, of course, what you should be aiming for. It will also free up cash you can use to invest in stocks that have more promising long-term prospects. Besides, if you sell only stocks that have gone up since you bought them, and hold those that have gone down or moved sideways, you run the danger of ending up with a portfolio of losers.
If you’re worried about the impact of a potential recession on your portfolio, you might want to consider including some defensive stocks in it. These include various food, beer and other consumer products stocks that sell products that consumers continue to buy — even in a recession.
This is an edited version of an article that was originally published for subscribers in the October 7, 2022, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.
The Investment Reporter, MPL Communications Inc.
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The Investment Reporter •11/8/22 •