A 7-step plan to tackle a bear market

Jun 03, 2022

TOM LAURICELLA, editor of Morningstar Direct, believes that it's time to think about how to navigate an environment where stocks clearly don't just go up.

A common piece of advice for investors during a big selloff in the stock market is to hang tight and not panic. That’s often misunderstood to mean “close your eyes and ignore what’s happening in your portfolio.”

Right now, with bear market tidings, the instinct to put your head in the sand may be understandable.

While you don’t want to respond with knee-jerk reactions to the down market, it’s also a time to take a close look under the hood of your portfolio and see how your plan matches up to what you expected and whether you’re still on track to meet your goals.

MARTA NORTON, chief investment officer for the Americas at Morningstar Investment Management, offers these steps for investors to consider as we weather these volatile markets.

  1. How robust is your portfolio?

One thing that we give a lot of thought to is the idea of robustness. This is related to diversification, but it's not quite the same thing. It's thinking about your portfolio and the different environments that you can be in: high economic growth, low growth, high inflation, and low inflation. If your entire portfolio depends on high growth and low inflation, then you don't have a robust portfolio.

Maybe you're buying something that is modestly cheap but would actually do really well in a particular environment. So you don't know how the market or the economy is going to play out. You can have a best guess, and you might be close or sometimes you might be off other times.

So it makes sense to think about those different ranges of environments and your portfolio—even within a single asset class. Even within equities you can ask yourself, "Which of these sectors is going to benefit in which environment?" For example, if we enter into a recession, financials are not a great place to be. If we don't hit a recession and rates are much higher, then there is something of a tailwind for financials. If we have a recession, maybe energy doesn't do so well. But if you have inflation, maybe energy does do well.

So you have all those these different considerations for different areas of the market and you need to think that through. 

3 mistakes equity investors make

  1. Look for buying opportunities. 

The Warren Buffett maxim should apply: Be greedy when others are fearful, and fearful when others are greedy.

As a general rule, if you care about the price that you're paying for things and the market is selling off hard—not just a modest decline here and there, but it's a significant selloff—then all else being equal, that is a buying opportunity.

When it comes to stocks, especially to the extent that the underlying assets of a company are not impaired, you're looking at healthy companies, healthy debt. So now that the prices are a lot better that is a good thing for long-term returns.

When we start to see a market selloff like this, we are always going to start to get interested and thinking about how to take advantage of the opportunity instead of just being a victim of it. I think this is a narrative that people understand well, but whether they actually behave that way is a different thing.

3 lessons from investment gurus

  1. Buy the Dip vs. Having a Plan.
Some investors don't buy dips, they sell rallies. Some are known for averaging up. Have a strategy that you believe in.

It is also important to distinguish from the hashtag that floats around social media nudging you to “buy the dip”. There's almost this sense of a trampoline, like the market is going to fall hard and it's going to be an immediate bounce back. It’s an instant gratification thing. I want to caution that, if it is a meaningful selloff, there can be more meaningful selloffs.

When we start to get interested in a market selloff, we don't take everything that we could put in the market and do it right away. We do this in a much more dollar-cost-averaging way, where we adjust and put together a buying plan. If the market’s down X amount I'll do this, the market's down X plus this amount I'll do that.

It’s a pre-commitment that can help counter behavioral bias, because, as the market sells off more and more, you start to wonder what the market is seeing that I don't. So having this pre-commitment in this type of environment can be a powerful way to do the right thing, even when it feels really bad.

Look at valuations, not index levels

  1. Don’t buy through the rearview mirror.

Down markets don't all look the same, and up markets don’t all look the same.

Stocks that have been chased won't be favorites anymore, and so you don't necessarily want to assume that this is just a dip and then you get back in, and it's going to be exactly the way it used to be. 

How to be a great investor

  1. Check your expectations.

This is not a recession yet, and this isn't a global financial crisis. This is a shifting of the market environment, where we're going from a benign inflationary environment to an inflationary environment, and we're going from an accommodative monetary policy to a less accommodative monetary policy.

To the extent to which it's been such accommodative policy and a positive economic environment that have bolstered security prices, then the next ten years may not be as friendly for returns as the last ten. Recalibrating expectations is important.

The biggest risk is around investor expectations

  1. Don’t lose sight of the basics.

It’s important to know that this type of market environment—the idea that bonds and stocks can be selling off at the same time—is within the realm of possibility.

As equities and bonds sell off at the same time, it can become hard to see the value of a multi-asset portfolio. But there are benefits to having a portfolio diversified with equity, debt, gold, commodities and real estate. They offer balance to your portfolio and ease the risk of concentration in one asset class.

5 timely reminders in Buffett's latest letter

  1. You don’t have to be right.

To have a portfolio that can meet a financial goal at the end of your time horizon, you don't have to be able to predict where the whole economy goes. You don't have to be a savant. You could make mistakes.

Just be willing to say "I could be wrong about this. What must I do to rectify that? What could I own that is reasonably priced that could offset that concern?"

5 things investors must not ignore

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