How to adapt to a bear market

Long-running bull markets makes many an investor wary because it seems as Newton’s Third Law states that for every action in nature there’s an equal and opposite reaction. So one would think surely a bear market is on its way.

For any evidence that this is so it is best to watch for signs that a bullish market is at its peak. The final stage of a bull market is overly jubilant behaviour marked by excessive speculation or more precisely when an Index has fallen by 20% or more.

But it impossible to predict when a bear market is going to happen.

It is impossible to predict when a bear market is going to happen.

Signals

The most obvious signs of a peak bull market is the surge in optimism accompanied by lots of activity in the market that means everything from more media stories and waves of share buying.

Other signs that the market may be at the top are more mergers and acquisitions (M&A) in a ‘fashionable’ sector. Ironically enough, you see more of M&A activity at the top of a market than you do at the bottom, according to Mark Dampier, head of research at Hargreaves Lansdown.

Another sign is if your friends who held zero interest in investing suddenly want to talk about the latest technology stock or worse, tell you that this investing lark is really easy and you can make 20-25% in a week.

Dot.com bubble

This is reminiscent of tech stocks in 1999 and 2000 during the Great Internet Bubble and if you’re old enough you may remember the failures of Boo.com and lastminute.com, although recovery happened for the latter.

Exuberance back then was not built on anything solid such as valuations that reflected earnings. Share prices fell like lead balloons and companies went bust.

Dampier says: “Markets are all about human emotion. I look out for my client wanting to buy more things, wanting to invest more money. The IFA getting excited about more investment, more funds. Those are the sorts of things that tend to mark the top of a market.”

Black Swan Event

The other thing that ends the bull market are the events you can’t foretell. It could be a political event or it could be a natural disaster. Basically a black swan event is something that you nor I could see today.

History is helpful when it comes to signs of what can signal a bear market.

Contrary to popular opinion it isn’t usually a single event that triggers a fall. Sometimes it’s just a big over valuation.

Dampier says, “If you go back to [October] 1987 most of the buyers were in. Most people were pessimistic when the market did start to fall there was no support for it. It was like an air pocket.”

What should investors look for when it comes to a slowdown in the UK stock markets?

• Gain perspective: Take a measured approach and look at the performance of the stock market over a number of periods with different starting points, to get a more rounded view of the returns investors have experienced (remembering that past performance is not a guide to the future).
• Hold your nerve. Prices may fall but history tells us the market will recover even if it takes some time. If you sell out each time the market tumbles and buy back in once the clouds have cleared you are likely to significantly reduce your overall investment returns.
• Seek bargains, but avoid value traps. The sell-off in markets may throw up interesting investment opportunities don’t simply invest in the hardest hit areas as it may be a quick way to financial loss. If you do go bargain hunting seek out companies with good long-term prospects trading at attractive prices, not just companies which have suffered heavy price falls.
• Consider topping up. If you’re adventurous and have a long-term horizon Hargreaves suggests it could be a good time to take advantage and seize the opportunity. However, don’t expect your purchase to signal the bottom of the market. If you are investing in this way you need to be willing to see your investment fall further, rather than expecting instant gratification.