How to survive the bear market

April 28, 2009
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, NAIROBI, Kenya, Apr 29 – The Bears and the Bulls have been synonymous with the stock market for centuries. Many people would ask, “What do they mean?” A “bear” market is one in which sellers outnumber buyers, as the value of shares falls consistently over time.

A “bull” market on the other hand is one in which share prices are consistently rising.

The name “bear” is derived from the phrase “bearskin jobbers” who were traders selling bearskins, often before they even had bear skins to sell. The origins of the name bull is unclear with some theorists suggesting that it arose from the notion that, while bears attack by pressing down on their victims, bulls do the opposite by throwing their victims upwards with their horns.

What most global stocks markets including the Nairobi Stock Exchange (NSE) in Kenya are facing at the moment is a bear market. This has had the effect of causing panic amongst investors who have flocked the stock market to sell their already under valued shares. Although this fear is understandable, it is based on panic rather than long-term consideration. It is important to seek the advice of your financial adviser before making any sudden and misinformed decisions. There are several steps you can take to survive a bear market.

The most important step in surviving a bear market is spotting it. A bear market is generally accepted as a sustained fall in stock market indices of more than 20 percent from a recent high. This should generally last longer than a few weeks and be across the index as opposed to individual stocks and sectors. In the case of the NSE, the drop in share prices has affected virtually all shares in all sectors (agricultural, commercial and services, finance and investment as well as industrial and allied).

Usually, there are three phases of a bear market:

Phase 1: A sharp fall in prices.

Phase 2: Bargain hunters move in and buy up “cheap stocks”, causing the markets to rise.

Phase 3: Demand falls further with a long and slow downward trend in share prices.

Upon surpassing the 20 percent mark, it is officially recognised as a bear market. Note that bear markets usually last for 16 months although some are known to have lasted four years or more.

The second step involves avoiding the bear. It is almost impossible to tell whether volatility in the markets is temporary or the beginning of a bear market. What would be of interest to an investor however, will be how to avoid the bear.

One way of avoiding a bear market is avoiding it altogether. This however, is not an option to many investors especially those with a long-term outlook. A better option would be to switch your investments into a “safer” option when markets are at or near the peak. This market timing is very difficult.

There are other approaches investors could adopt to minimise the bear market’s impact.

One of them is minimising panic and investing wisely irrespective of the short or medium term performance of your investment.

During a bear market, it is important to keep the volatility of your investment portfolio to a minimum. The simplest way is to spread the risk by investing in different asset classes. These include cash, fixed interest and property.

In times of market downturn, cash is often considered somewhat a short-term safe haven. Whilst returns may not be huge, investments in cash should be generally safe and receive interest on capital.

Another defensive option available to an investor is non-equity investments. These are usually lower risk and have comparatively lower returns. Note, however, that no investment is 100 percent secure, as during the “credit crunch”, banks were hit hard and cash may not be as safe as it once was.

Fixed interest investments or bonds are considered less risky than equities. They work as fixed term loans to the government or corporations providing the bond paying fixed interest to the end of the term.

Property may be either commercial or residential. In a bear market, falling interest rates make it cheaper to borrow money to buy properties. From a risk perspective, property is generally considered to be somewhere between equities and bonds.

As always, a bear market is the best market in which to buy. Sir John Templeton once said, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell.” However, you should seek the help from the expertise of your financial adviser in devising a sound investment strategy.

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