How to Prepare for Next Bear Phase in Stock Market?

What exactly do we understand by a bear phase in the stock market? While there is no hard and fast definition of a bear market, the accepted standard definition is a correction of 20% from the peak of stock market. It is normal for stock broker and investors to panic in the face of a bear market and act instinctively. The result is that you end up losing opportunities which the bear market offers. Bear markets are not about jumping in and buying every stock that has corrected. Here is how you can prepare for a bear market.

Remember, bear markets are always more severe on some sectors

If you look back at the bull markets of the last 25 years, then the bear markets subsequent to such rallies have followed a similar pattern. The maximum damage has happened in stocks that triggered the rally in the first place. Post 1992, it was the cement pack that corrected the sharpest. Post the technology rally in 1999 even frontline stocks like Wipro and Infosys corrected more than 75%. Much worse was the damage to realty and infrastructure stocks post 2008. Most of the stocks lost over 95% of their peak value. As a strategy, prepare to exit the drivers of the bull rally first in any bear market. Such stocks are not meant to be bought on dips. This is the basic rule that should guide stock broker strategy in the bear phase of stock market.

Stay low on leveraged positions in the market

The problem with bear markets is that they are also accompanied by a rise in volatility and a fall in buying demand. This widens the spreads on stocks. In the markets, you can be leveraged in two ways. You can either borrow to invest or you can trade on margin. In both cases, bear markets are the time to cut down on your leveraged positions. Even if your view is right, the spurt in volatility may trigger stop losses. Minimize your leveraged positions in a bear market as it can draw you into a vicious cycle of trading losses.

Look for asset classes beyond equity

More often than not, we end up believing that equities are the only place to invest and end up making wrong decisions. There are asset classes beyond equity that can protect value in bad times. For example, gold has typically done very well when equity markets have fallen. Similarly, liquid funds and debt funds can also give much more stability to your portfolio. Even within your equity portfolio, look to diversify across themes. If you spread your portfolio across themes and sectors, you stand a very good chance of doing well compared to putting all your eggs in one basket.

Bear market is the time to restructure and rebalance your portfolio

If you were waiting for the right time to change your portfolio mix, then for stock broker the bear stock market is the right time to rebalance and restructure your portfolio . As we said earlier, first get out of the stocks and themes that triggered the bull market in the first place. Shift your stocks from high beta names to low beta names. They will hold value much better. In any bear market, the mid caps and small caps face the maximum damage. You can prepare yourself by shifting out of such stocks well in advance. Focus more on companies that follow relatively higher standards of corporate governance and disclosure practices. They are likely to give fewer negative surprises in a bear market.

If we can just focus on these defences, bear markets can be easily and methodically handled!