Eat the Bear (Before the Bear Eats You)

There’s an old expression: some days you eat the bear, and some days the bear eats you. Lots of investors got chomped earlier this month. Below, I’ll show you five time-tested ways to bear-proof your portfolio.

Markets have somewhat recovered from their dizzying falls in the beginning of February. But from its peak on January 26 to its intraday low on February 9, both the Dow Jones Industrial Average and the S&P 500 Index fell about 12% in only two weeks.

Consider February 5, when the Dow dropped 1,175 points, its worst single-day point decline ever. As the chart shows, it was an adrenaline-pumping session:

Think the excitement is over? Not by a long shot.

Interest rates are rising; bull markets typically are killed by higher rates. The yield on the benchmark 10-year Treasury note flirts with 3%. Higher bond yields entice investors who seek income, and they also dampen economic growth by making it more expensive to borrow money. Both scenarios are bad for stocks.

What’s more, political risk has returned, with a vengeance. Last Friday, Special Counsel Robert Mueller announced indictments of 13 Russians and three Russian groups for meddling in American elections. More indictments will come. The White House is under siege.

Bear markets in stocks are defined as downturns, from peak to trough, of at least 20%. Since 1929, the U.S. stock market has undergone 25 bear markets, an average of one every 3.4 years. We’re overdue. The most recent bear market ended in March 2009, nearly nine years ago.

Bear markets usually don’t occur without an economic recession and, right now, none is on the horizon. The economic news remains ostensibly good.

However, by implementing regressive tax cuts and massive deficit spending, Washington, DC just embarked on an extraordinary gamble. When the next economic downturn occurs, fiscal and monetary policymakers will have fewer tools at their disposal. Investors have been partying like it’s… well, like 2008.

In the context of this uncertainty, you either can flee to safety (and receive dismal returns), do nothing (and get slaughtered), or be proactive and take decisive measures to simultaneously hedge your portfolio and profit.

Five Proactive Steps

Here are five ways to protect your portfolio from the next severe slump:

1. Make sure your portfolio contains gold.

Market volatility will probably propel the price of gold in the coming months. The rule of thumb is for an allocation of 5%-10% in either gold mining stocks, exchange-traded funds (ETFs) or the physical bullion itself. Gold prices are now poised for a rebound, as worried investors flee to safe havens.

Goldman Sachs (NYSE: GS) this month raised its gold price forecasts. The investment bank now expects the price of the Midas Metal to reach $1,350, $1,375, and $1,450 per ounce over the three, six and twelve months period respectively, versus its previous forecast of $1,225, $1,200, and $1,225/oz. As of this writing, gold hovered at $1,357/oz.

As the reason for its revision, Goldman Sachs cited stirring inflation, more robust emerging market growth, rising commodity prices, and worsening geopolitical risk.

GS also pointed to upward pressure from stronger emerging market currencies against a weaker U.S., as well as potential for hedging demand in a highly volatile market environment.

The conditions that are favorable for gold will prove fatal for overvalued stocks that are looking for a trigger to tumble. The time to buy gold is now, before panic buying bids up the price of gold investments.

2. Decrease your portfolio’s weighting in momentum stocks.

This is no time to be heavily weighted in overpriced momentum stocks, especially large-cap technology stocks. Rotate into non-cyclical, more stable companies that provide services that are consistently used regardless of market or economic conditions.

Pare back your exposure to the media-hyped, Wall Street darlings that trade at excessive multiples. Pocket partial gains from your big winners. Elevate cash levels to at least 20%.

3. Diversify among asset categories.

Spread your portfolio among value, large-cap, mid-cap, small-cap, growth and dividend stocks. One often ignored move is to invest in mid-caps, which provide greater growth potential than large caps but less risk than small caps.

Small cap is generally defined as a company with a market capitalization of between $300 million and $2 billion. Mid cap is valued at between $2 billion and $10 billion.

4. Seek global diversification.

Don’t withdraw from the world stage and become a parochial investor. Investors are enjoying simultaneous growth in countries around the world.

In a recent report, the International Monetary Fund said 120 economies accounting for three-quarters of global economic activity experienced growth in 2017. The expansion affected developed and emerging economies. It’s the broadest “synchronized” global growth since 2010.

As commodity prices rise and middle classes expand, emerging markets are off the ropes. The IMF expects this robust pace of global growth to continue in 2018.

5. Use stop losses

One of the most widely used devices for limiting the level of loss from a dropping stock is to place a stop-loss order with your broker. Using this order, the trader will pre-set the value based on the maximum loss the investor is willing to tolerate.

If the last price drops below this fixed value, the stop loss automatically becomes a market order and gets triggered. As soon as the price falls below the stop level, the position is closed at the current market price, which prevents any additional losses.


John Persinos is managing editor of Personal Finance and chief investment strategist of Breakthrough Tech Profits.

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