Making Money in a dual Bear Market

[otherbarry]

Entertain the idea, if you will, that the naysayers are right. Stocks are about to take a plunge and interest rates are about to skyrocket. This effectively means neither long term bonds nor common stocks will give that good a return. Assuming I have foresight of this event, what would I need to invest in to maximize returns and minimize losses?

[ak907]

Once the stocks crash put all your money into stocks. They will come back, and when they do you will get a great return on investment, you may have to wait 2-5 years but it will be huge. Personally I am excited for the next crash I am going to sell a bunch of bonds off and put all the money in the crashed stock market index.

[dragoncar]

Cash

[soccerluvof4]

^ second that.....Cash.  So if you feel its time!! then start stashing some cash :-)

[Cheddar Stacker]

Cash

+1.

I'm not sophisticated enough to tell you how to buy shorts and sell puts or whatever all that stuff means, but I think that's where the real play would be. If that's over your head like it is mine, then CASH.

But, I'm not going to make that assumption. No change for me.

[sol]

Betting on market movements is easy.  If you have enough foresight to know when the crash will happen, short the indices.  Step 2: profit.

I'm not a fan of cash because it is guaranteed to lose value over time.  We haven't really had deflation in this country for almost a century, just inflation on inflation on inflation, carefully manged by central bankers.  I predict that trend will continue, meaning that cash is always going to be a loser.

Now SPENDING your cash, that's a different story.  If you think the market is going to crash hard and aren't prepared to actually short the crash, then reallocating some money (that you would have otherwise invested) into other profitable ventures might be worthwhile.   Is your house about to need a new roof?  Time to replace a vehicle?  Want to buy solar panels, or upgrade the insulation in your house?  Spending money on long term capital improvements that you're going to have to make eventually anyway is a better option than buying into a market right before a crash.

[matchewed]

For this simple hypothetical (you know that stocks will crash in X days...), like everyone else said, cash.

Outside of the hypothetical follow your investment plan because you don't know when a crash is coming.

[Kaspian]

That's right.  Don't try and time or predict the market.  Even the experts can't do that.  Stick to your plan, rebalance when necessary, and as Bogle says, "ignore the noise".

[otherbarry]

I think I was unclear in my intial question, I don't mean a sudden crash. I'm talking about a long drawn out bear market, where stocks maybe correct suddenly then continue to decline slower. And bond prices also decline as interest rates creep up. What I'm saying is should you change your strategy from index funds to individual bonds and just earn fixed income or is there a better way to capitalize off bear markets. I've heard of options but haven't researched enough to fully understand them except that selling is extremely risky.

[matchewed]

So hypothetically if we had a Japan situation coming up and you knew it what would be a profitable decision?

Still cash IMO. Interest rates creep up thereby increasing the interest rate on a savings account and CD's. Stocks are stagnant not giving anywhere close the aforementioned interest rate and bonds are down too given the rising interest rate. The answer still hasn't changed because the situation really hasn't changed, just the length of it. Your basic assumptions are still there, doesn't matter if it's two years or 10 years.

[Cyrano]

If you were a Japanese person in 1991 with the foresight to know that all Japanese asset prices were insane and it would take 10-20 years to rebalance the system, you would have done well to have invested in US stocks.

So on the hypothetical that you absolutely know that all dollar denominated investments are ridiculously overpriced, and total real return on US stocks will be approximately zero for the next 10-20 years, with similar zero real returns in the bond market, you might do a lot worse than a low expense international value stock fund.

[foobar]

I think I was unclear in my intial question, I don't mean a sudden crash. I'm talking about a long drawn out bear market, where stocks maybe correct suddenly then continue to decline slower. And bond prices also decline as interest rates creep up. What I'm saying is should you change your strategy from index funds to individual bonds and just earn fixed income or is there a better way to capitalize off bear markets. I've heard of options but haven't researched enough to fully understand them except that selling is extremely risky.

You run into timing issues. If I knew the S&P 500 would be lower in 5 years, there are products to let you make money. In the real world, I am pretty confident in a 20-30% correction in the next 5 or so years. But I can't tell you if it will be after the S&P 500 doubles again or if it will happen tomorrow.

You can diversify into things like commodities and gold but it is a crap shoot if they will do well.  There isn't a high return product that is the inverse of stocks.

People are suggesting cash but you can easily get into a high inflationary environment where that is a losing play. Imagine for example the US dollar dropped in half versus the asian currencys and that 1k tv now cost 2k. Or if Oil starts trading in Euros and the US dollar drops. You suffer a ton of inflation but no gain in interest rates to offset that.

You can google the Permant Portfolio which tries to maintain steady returns by having different asset classes for different types of markets. It has worked well over the past 40 years but I  have to admit I always think they picked a good period for it to come out (and unfortunately you can't really back test since gold wasn't an investment option before 1970).

[surfhb]

I think I was unclear in my intial question, I don't mean a sudden crash. I'm talking about a long drawn out bear market, where stocks maybe correct suddenly then continue to decline slower. And bond prices also decline as interest rates creep up. What I'm saying is should you change your strategy from index funds to individual bonds and just earn fixed income or is there a better way to capitalize off bear markets. I've heard of options but haven't researched enough to fully understand them except that selling is extremely risky.

The worst 30 year period was around 7% during the 20s into the 50s.   The best was 12% from the 50s into the 90s.   

OP.  I think your best bet is to invest in a good set of index funds ;).   You're worrying about what you can't control

[dragoncar]

I think I was unclear in my intial question, I don't mean a sudden crash. I'm talking about a long drawn out bear market, where stocks maybe correct suddenly then continue to decline slower. And bond prices also decline as interest rates creep up. What I'm saying is should you change your strategy from index funds to individual bonds and just earn fixed income or is there a better way to capitalize off bear markets. I've heard of options but haven't researched enough to fully understand them except that selling is extremely risky.

You run into timing issues. If I knew the S&P 500 would be lower in 5 years, there are products to let you make money. In the real world, I am pretty confident in a 20-30% correction in the next 5 or so years. But I can't tell you if it will be after the S&P 500 doubles again or if it will happen tomorrow.

You can diversify into things like commodities and gold but it is a crap shoot if they will do well.  There isn't a high return product that is the inverse of stocks.

People are suggesting cash but you can easily get into a high inflationary environment where that is a losing play. Imagine for example the US dollar dropped in half versus the asian currencys and that 1k tv now cost 2k. Or if Oil starts trading in Euros and the US dollar drops. You suffer a ton of inflation but no gain in interest rates to offset that.

You can google the Permant Portfolio which tries to maintain steady returns by having different asset classes for different types of markets. It has worked well over the past 40 years but I  have to admit I always think they picked a good period for it to come out (and unfortunately you can't really back test since gold wasn't an investment option before 1970).

You have to put your money somewhere... and if stocks and bonds are falling in nominal terms, cash will at least be growing in nominal if not real terms.  And if bonds are falling, then you are probably getting decent interest on your cash.

[hodedofome]

It's wrong to assume that interest rates have to rise and stocks will fall at the same time. Stocks can go down while interest rates go down as well. Just look at Japan. Stocks and interest rates going down for over 20 years. The play there was to be out of stocks and holding JGBs (if you wanted to maintain home-country bias).

[matchewed]

It's wrong to assume that interest rates have to rise and stocks will fall at the same time. Stocks can go down while interest rates go down as well. Just look at Japan. Stocks and interest rates going down for over 20 years. The play there was to be out of stocks and holding JGBs (if you wanted to maintain home-country bias).

You didn't read the hypothetical question did you?

[otherbarry]

I think I was unclear in my intial question, I don't mean a sudden crash. I'm talking about a long drawn out bear market, where stocks maybe correct suddenly then continue to decline slower. And bond prices also decline as interest rates creep up. What I'm saying is should you change your strategy from index funds to individual bonds and just earn fixed income or is there a better way to capitalize off bear markets. I've heard of options but haven't researched enough to fully understand them except that selling is extremely risky.

The worst 30 year period was around 7% during the 20s into the 50s.   The best was 12% from the 50s into the 90s.   

OP.  I think your best bet is to invest in a good set of index funds ;).   You're worrying about what you can't control

I'm not worried about control, I've heard of people saying "best investors can make money in any type of markets" and was just wondering some of the techniques in an extended bear market. Looks like foobar revealed some of them.

Majority so far seem to say just stick your money in a high interest savings account. That seems boring but I guess it's a decent method. Thanks for the insight guys.

[hodedofome]

It's wrong to assume that interest rates have to rise and stocks will fall at the same time. Stocks can go down while interest rates go down as well. Just look at Japan. Stocks and interest rates going down for over 20 years. The play there was to be out of stocks and holding JGBs (if you wanted to maintain home-country bias).

You didn't read the hypothetical question did you?

I read it, did you?

"Stocks are about to take a plunge and interest rates are about to skyrocket. This effectively means neither long term bonds nor common stocks will give that good a return."

Inherit in this assumption is that stocks will plunge and interest rates will go up. My answer was that this correlation (or anti-correlation) isn't always the case.

[matchewed]

Investing for your life isn't about the level of excitement, but measuring your risk tolerance with potential returns. Keep that in mind when evaluating a particular choice and weighing the "boringness" of it adds zero value to the analysis. If you're just screwing around with fun money then by all means go for excitement if that's your thing.

[matchewed]

It's wrong to assume that interest rates have to rise and stocks will fall at the same time. Stocks can go down while interest rates go down as well. Just look at Japan. Stocks and interest rates going down for over 20 years. The play there was to be out of stocks and holding JGBs (if you wanted to maintain home-country bias).

You didn't read the hypothetical question did you?

I read it, did you?

"Stocks are about to take a plunge and interest rates are about to skyrocket. This effectively means neither long term bonds nor common stocks will give that good a return."

Inherit in this assumption is that stocks will plunge and interest rates will go up. My answer was that this correlation (or anti-correlation) isn't always the case.

Yeah and I read the whole thing where he asked to entertain the idea that stocks take a plunge and interest rates skyrocket. In effect asking the hypothetical question of that specific scenario and your answer is... consider not your scenario? So remind me again who read what...

[hodedofome]

I think I was unclear in my intial question, I don't mean a sudden crash. I'm talking about a long drawn out bear market, where stocks maybe correct suddenly then continue to decline slower. And bond prices also decline as interest rates creep up. What I'm saying is should you change your strategy from index funds to individual bonds and just earn fixed income or is there a better way to capitalize off bear markets. I've heard of options but haven't researched enough to fully understand them except that selling is extremely risky.

The worst 30 year period was around 7% during the 20s into the 50s.   The best was 12% from the 50s into the 90s.   

OP.  I think your best bet is to invest in a good set of index funds ;).   You're worrying about what you can't control

I'm not worried about control, I've heard of people saying "best investors can make money in any type of markets" and was just wondering some of the techniques in an extended bear market. Looks like foobar revealed some of them.

Majority so far seem to say just stick your money in a high interest savings account. That seems boring but I guess it's a decent method. Thanks for the insight guys.

There are a few ways that guys 'make money in any environment.' One is simply to use momentum/relative strength across the major asset classes and then switch into the asset class that's recently done the best. Meb Faber, Dorsey Wright & Associates and Gary Antonacci have research on this style of investing. So say you have the following asset classes:

US Stocks
Int'l Developed Stocks
Emerging Market Stocks
US Treasury Bonds
Commodities
REITs

You measure the returns each asset class has done for the past 12 months. Pick the top 3 asset classes (the top 50% essentially) and hold them for a month. Do this every month (look back at the past 12 months, find the top 3, buy them for a month. If the past 12 month returns for one of the top 3 asset classes is negative (meaning it's going down, not up), then hold that portion of the portfolio in cash. This way you are only owning the assets that are going UP, not the ones going DOWN.

A strategy like this (without any slippage or taxes) has returned 14% a year with a max drawdown of 20% since 2003. S&P 500 has returned 8.7% and max DD of 55.2% in the same timeframe.

Or you may have several strategies that you use (like value, momentum, counter-trend, day-trading) and switch into the strategy that is working 'right now.' A trader may use a mechanical system to choose between strategies or he may just use his intuition. This is essentially having a bunch of tools in your toolbox. What does the current market environment call for? Figure that out, then choose the strategy that fits the environment the best.

There are options guys out there who try to determine the type of market environment we are currently in and choose the option strategy that makes the most money in that environment. Are we in a mean-reverting environment? There's an option strategy for that. Are we in a flat-market? He may sell calls and puts since prices aren't going anywhere and he thinks most options will expire worthless. Are we in a trending environment? He may buy calls and puts since he thinks prices will continue in a certain direction. Or - are we in a low volatility environment? Options may be cheap so he's buy. High volatility environment? He may sell options because they are expensive and expects the market to calm down.

An example of this is here http://www.zentrader.ca/blog/?p=22053

Or, a global macro guy may use value investing across global markets and asset classes and choose the ones he considers to be the cheapest, and possibly short the ones he considers to be the most expensive.

[otherbarry]

Investing for your life isn't about the level of excitement, but measuring your risk tolerance with potential returns. Keep that in mind when evaluating a particular choice and weighing the "boringness" of it adds zero value to the analysis. If you're just screwing around with fun money then by all means go for excitement if that's your thing.

Just saying I know there's riskier methods than "stick it in a savings account" which is what hodedofome brought up. Also don't you know the boring ratio? Volatility/(price*shares you bought using kid's college fund)

[surfhb]

I think I was unclear in my intial question, I don't mean a sudden crash. I'm talking about a long drawn out bear market, where stocks maybe correct suddenly then continue to decline slower. And bond prices also decline as interest rates creep up. What I'm saying is should you change your strategy from index funds to individual bonds and just earn fixed income or is there a better way to capitalize off bear markets. I've heard of options but haven't researched enough to fully understand them except that selling is extremely risky.

The worst 30 year period was around 7% during the 20s into the 50s.   The best was 12% from the 50s into the 90s.   

OP.  I think your best bet is to invest in a good set of index funds ;).   You're worrying about what you can't control

I'm not worried about control, I've heard of people saying "best investors can make money in any type of markets" and was just wondering some of the techniques in an extended bear market. Looks like foobar revealed some of them.

Majority so far seem to say just stick your money in a high interest savings account. That seems boring but I guess it's a decent method. Thanks for the insight guys.

That's not true at all.    Fact is most investors never beat the indexes over long periods of time.   If you'd like to try then be my guest.   As I see it, since not even the best and brightest financial gurus on wall st can't manage to beat a simple S&P index fund then don't you think to have better things to do with your time?    Think about that for a minute?     These are professional fund managers!   

[otherbarry]

I'm not worried about control, I've heard of people saying "best investors can make money in any type of markets" and was just wondering some of the techniques in an extended bear market. Looks like foobar revealed some of them.

Majority so far seem to say just stick your money in a high interest savings account. That seems boring but I guess it's a decent method. Thanks for the insight guys.

That's not true at all.    Fact is most investors never beat the indexes over long periods of time.   If you'd like to try then be my guest.   As I see it, since not even the best and brightest financial gurus on wall st can't manage to beat a simple S&P index fund then don't you think to have better things to do with your time?    Think about that for a minute?     These are professional fund managers!   

Is this the opposite of those bots offering the next hot tip to make you millions?

[surfhb]

I'm not worried about control, I've heard of people saying "best investors can make money in any type of markets" and was just wondering some of the techniques in an extended bear market. Looks like foobar revealed some of them.

Majority so far seem to say just stick your money in a high interest savings account. That seems boring but I guess it's a decent method. Thanks for the insight guys.

That's not true at all.    Fact is most investors never beat the indexes over long periods of time.   If you'd like to try then be my guest.   As I see it, since not even the best and brightest financial gurus on wall st can't manage to beat a simple S&P index fund then don't you think to have better things to do with your time?    Think about that for a minute?     These are professional fund managers!   

Is this the opposite of those bots offering the next hot tip to make you millions?

Yes.....its call intelligent investing :)

[foobar]

You measure the returns each asset class has done for the past 12 months. Pick the top 3 asset classes (the top 50% essentially) and hold them for a month. Do this every month (look back at the past 12 months, find the top 3, buy them for a month. If the past 12 month returns for one of the top 3 asset classes is negative (meaning it's going down, not up), then hold that portion of the portfolio in cash. This way you are only owning the assets that are going UP, not the ones going DOWN.

A strategy like this (without any slippage or taxes) has returned 14% a year with a max drawdown of 20% since 2003. S&P 500 has returned 8.7% and max DD of 55.2% in the same timeframe.

I don't mind the strategy  in theory, please never follow anyone who is only using a 10 year period to prove their system works. There is no reason why for a strategy like that that you can't post numbers based on the last 40+ years.

[hodedofome]

You measure the returns each asset class has done for the past 12 months. Pick the top 3 asset classes (the top 50% essentially) and hold them for a month. Do this every month (look back at the past 12 months, find the top 3, buy them for a month. If the past 12 month returns for one of the top 3 asset classes is negative (meaning it's going down, not up), then hold that portion of the portfolio in cash. This way you are only owning the assets that are going UP, not the ones going DOWN.

A strategy like this (without any slippage or taxes) has returned 14% a year with a max drawdown of 20% since 2003. S&P 500 has returned 8.7% and max DD of 55.2% in the same timeframe.

I don't mind the strategy  in theory, please never follow anyone who is only using a 10 year period to prove their system works. There is no reason why for a strategy like that that you can't post numbers based on the last 40+ years.

It was an example based on the data I had with me. I literally just threw it together in 3 minutes on etfreplay.com. If someone is dumb enough to take an example system posted on a forum and trade it blindly, they deserve to lose money. I would never tell someone to blindly trade a system I used just as an example.

FWIW Meb Faber and Gary Antonacci have published very similar systems with very similar performance going back to the '70s.

[otherbarry]

You measure the returns each asset class has done for the past 12 months. Pick the top 3 asset classes (the top 50% essentially) and hold them for a month. Do this every month (look back at the past 12 months, find the top 3, buy them for a month. If the past 12 month returns for one of the top 3 asset classes is negative (meaning it's going down, not up), then hold that portion of the portfolio in cash. This way you are only owning the assets that are going UP, not the ones going DOWN.

A strategy like this (without any slippage or taxes) has returned 14% a year with a max drawdown of 20% since 2003. S&P 500 has returned 8.7% and max DD of 55.2% in the same timeframe.

I don't mind the strategy  in theory, please never follow anyone who is only using a 10 year period to prove their system works. There is no reason why for a strategy like that that you can't post numbers based on the last 40+ years.

It was an example based on the data I had with me. I literally just threw it together in 3 minutes on etfreplay.com. If someone is dumb enough to take an example system posted on a forum and trade it blindly, they deserve to lose money. I would never tell someone to blindly trade a system I used just as an example.

FWIW Meb Faber and Gary Antonacci have published very similar systems with very similar performance going back to the '70s.

What the hell I just spent my entire life savings!! Seriously though that reminded me of the Foolish Four technique somewhat.

[lano]

If stocks are going to go down in value over the next five years, the absolute best thing you can possibly do is to buy those very same stocks over that period of time.

[AlmstRtrd]

Permanent Portfolio. If stocks and bonds are both plunging, gold will go up. Ditto with cash yields. You'd then sell your winners down to 25% each and buy up stocks and bonds at a discount.

[cpa cat]

If stocks are going to go down in value over the next five years, the absolute best thing you can possibly do is to buy those very same stocks over that period of time.

This person is correct. The best thing to do in the face of a downward market is to have a well-diversified portfolio so that you can sell your high stocks and buy value stocks when they're low.

[AlmstRtrd]

Agree with Iano and Cpa Cat but I think the PP will preserve your wealth when the markets are dropping. In the scenario you describe, both stocks and bonds will be a screaming buy at some point but you want to be able to take from a winner and contribute to a loser.

[ect]

For this simple hypothetical (you know that stocks will crash in X days...), like everyone else said, cash.

People are suggesting cash but you can easily get into a high inflationary environment where that is a losing play.

Does "cash" assume that you must be denominated in your home currency? Currency diversification would seem to reduce risk. But I haven't found a cheap way of acquiring foreign currency exposure :(

[matchewed]

For my answer of cash, yes I mean your home currency primarily in a savings, CD, or other avenues associated with positive interest rate movement as put into the assumption.

[foobar]

You measure the returns each asset class has done for the past 12 months. Pick the top 3 asset classes (the top 50% essentially) and hold them for a month. Do this every month (look back at the past 12 months, find the top 3, buy them for a month. If the past 12 month returns for one of the top 3 asset classes is negative (meaning it's going down, not up), then hold that portion of the portfolio in cash. This way you are only owning the assets that are going UP, not the ones going DOWN.

A strategy like this (without any slippage or taxes) has returned 14% a year with a max drawdown of 20% since 2003. S&P 500 has returned 8.7% and max DD of 55.2% in the same timeframe.

I don't mind the strategy  in theory, please never follow anyone who is only using a 10 year period to prove their system works. There is no reason why for a strategy like that that you can't post numbers based on the last 40+ years.

It was an example based on the data I had with me. I literally just threw it together in 3 minutes on etfreplay.com. If someone is dumb enough to take an example system posted on a forum and trade it blindly, they deserve to lose money. I would never tell someone to blindly trade a system I used just as an example.

FWIW Meb Faber and Gary Antonacci have published very similar systems with very similar performance going back to the '70s.

The point was the numbers you listed were useless.  Posting them suggest the theory works but the reality is that we have no way of knowing if your just capturing variance. I love reading Meb Fabers works. I would note that so far I haven't seen a fund from him that outperforms the market. It is easy to back test up a strategy. It is a lot harder for it to continue to work in the near future. When the new papers comes out in 20 years they will use 6 or 18 months (instead of 12) as the window for capturing momentum. It will give great results but isn't very useful to me:)

[hodedofome]

Meb's first paper came out in '06 and the strategy as he originally described has performed well since then. The problem with his fund was partly the fees were way too high to overcome and they made it too complex compared to the simple one in the paper. Simple is almost always better.

Since momentum has been written about in papers and books (we're talking back to the '20s and' 30s) a 6 to 12 month look back window has typically been used. This was confirmed in the data for the 1993 paper when academics 'discovered' momentum for themselves. So we're looking at about 20 years out of sample and it still works. Not horrible if you ask me.

What's special about 12 months? I don't know. What's special about a P/E under 10? That's a number picked from the data but it works and value investors all over the world use it.

Momentum has been used for at least 100 years before value investing came along, and I've seen backtests going back 800 years. If you believe in the robustness of value investing, you should doubly believe in the robustness of momentum. There's so much more data to test the robustness of momentum.

[bacchi]

Sell covered calls. If you like an ETF or stock that you own, sell a call on it maybe 5% out. As the market declines, sell another one each month. You can do this all the way down. It'll cap your bull returns, of course, but in a slow falling market, there aren't any.

Now all you have to do is know when there's a bear and also when the bull returns.

[otherbarry]

So far from what I've gathered, if someone knew of the impeding bear markets their best course of action would be to:

-Sell all domestic stocks and bonds at their peak (because the all-knowing guy you are in this scenario doesn't need to guess)
-Keep what international stocks you own (assuming the foreign economy is performing normally)
-buy stocks and bonds ( favoring stock purchases) as they fall to guarantee huge return when bear markets end
-use money to invest in skills that can provide more income
-play around with options at your own risk

[TreeTired]

Cash,  and make sure your cash is indeed cash  (ie, liquid AND safe).   During the financial crisis, 2008 and 2009,  corporations and individuals lost a lot of money on positions that were carried as "cash".   In other words, they thought their money was in a very safe place but it actually was not. 

At some point in 2007 (or maybe it was already 2008) I started to get a little bit worried about my money market mutual funds.   I had a lot of funds in "cash" and a lot of that was in Schwab money funds.  When I researched what these funds held, I was horrified and moved all my cash into the US Treasury-only money market fund.  Of course a few months later the Fed put out a blanket guarantee on all money market funds and I felt like an idiot, but the typical money fund was not buying corporate commercial paper, but instead was buying debt of special purpose nonbank corporations that were themselves buying all kinds of garbage asset-backed paper.
Didn't look safe to me at all.

[ProfWinkie]

Look at Long-Short funds they operate like a hedge funds and usually do OK in down markets