Top 5 Bear Market Strategies
If you’re researching how to make money in a bear market, we offer some ideas. Bear market strategies haven’t been the focus for many investors but today’s retirees and baby boomers really should incorporate some bear market strategies into their portfolios. Running this idea past your financial advisor may offer some peace of mind during volatile times.
Here are our Top Five Bear Market Strategies:
1) Raise Cash
Many brokers won’t like this idea because they don’t get paid when you hold cash. They may admon you on the idea that “if you’re going to pay me a ‘wrap-fee’ to sit in cash”? Cash, cash equivalents and money market funds are a viable asset class in and of themselves and should be thought of as such. The ‘wrap-fee’ you pay your broker should be for a comprehensive plan based on your goals and risk tolerances. This should include cash. If you have low risk tolerance or are already in retirement, you should already have elevated cash levels. Cash will offer a return once rates normalize and very short-term cash equivalents such as U.S. T-Bills are continuously rolled over. Also, their purchasing power will increase in the event of deflation. Raising cash is the most conservative of the bear market strategies.
Of course, if you happen to be on margin you need to raise cash because your losses will be magnified in a severe bear market. You definitely don’t want a leveraged account in a bear market. You will get a margin call from your broker when your account value gets low enough, and you’ll need to raise cash immediately. If you’re not there, your broker or a margin clerk will sell them for you until your account is off margin. Of course, they will sell what’s easiest or most liquid to raise the cash. If they have the choice of selling your 200 shares of Apple or trying to locate a bid in the gray market for your odd lot shale bond, you can be sure they’ll opt for the quickest way to raise cash. Even if they do manage to sell an illiquid security, their discretion may be hasty in a panic. In other words, they may place market orders and you could get a horrendous print. Unfortunately, even once you get off of margin you’re still probably leveraged since the capital structures and debt-raising activities of many “blue chip” companies have already put shareholders on margin.
2) Include Alternative ETFs
There are several new ETF offerings marketed as alternative ETFs. These alternative ETFs offer strategies including market-neutral, long-short, currency-hedged, tail-risk hedged, etc. There is a strong appetite for actively managed products, which is common in a turbulent market. Some of the best alternative ETFs incorporate risk-management and hedging strategies and appear to work quite well. But many are still new so time will tell how they hold up.
Alternative ETFs should challenge the hedge fund industry for assets in the future. They offer similar strategies without the downside of being qualified (accredited), lock-up provisions and lack of transparency. They are also cheaper than investing directly in hedge funds or private equity funds (in terms of fees plus no performance bonus). One ETF I continually see on my screen acting well as a hedge is PowerShares S&P 500 Downside Hedged Portfolio ETF, PHDG.
3) Consider Inverse ETFs
Inverse ETFs can be a good way to make money during a stock market crash or severe bear market. If the market goes down in a persistent manner, these funds should do quite well and hold up better than any long position. But they are probably best suited for active traders since they are designed for used on an intra-day basis, given the daily reset. They are the ideal candidate for a “selling the rips” mentality. There are several inverse ETFs that offer great hedging benefits. Refer to our list of the Best Inverse ETFs for our favorite ideas. When markets get bad enough, investor’s mentality will switch from mitigating portfolio losses to seeking profit from the market’s downtrend.
4) Options Strategies
Buying ‘protective puts’ is one of our favorite bear market strategies. A protective put is a term used to describe the purchase of a put option contract being used as a hedge against an underlying investment in your portfolio. But you may have several different types of stocks, ETFs, etc around so should you do dozens of options strategies and positions. You can, but here is a simpler idea. Buy a long-dated put option representing the broadest stock market index. The Standard & Poor’s Depository Receipts or SPY seems like a good candidate. The theory being that you have a portfolio full of various stocks, mutual funds, ETFs, even other asset classes that are correlated, or likely to become correlated, with equities. Long-dated options, called LEAPs, are available for many securities and some go out 2-3 years. Also, the SPY, and its options chains, are some of the most liquid securities available in the markets. Probably the best choice to hedge equity exposure is longest dated put option available on the S&P 500 Depository Receipt or SPY. This addresses 1- the timing problem of when a sell-off will occur and 2- the illiquidity evident in many single name or small cap equity options. one aspect of the holding period problem away from inverse ETFs.
Drawbacks include illiquid traded bid asks (when dealing with smaller cap or esoteric securities, especially around news events and other volatile environments). But there is still counterparty risks and long holding periods where the time decay works against you, but mostly as you near expiration. Extra paperwork exists and an online application for options trading.
5) Short Selling
Short selling stocks is a bearish strategy that involves borrowing a stock from your broker, selling it and buying it back at later date and returning it to your broker. The hope for the short seller is that you sell the stock at a higher price than you buy it back for. It’s the same buy low, sell high strategy just in reverse. Shorting stocks is one of the best bear market strategies but it often becomes the scapegoat for market sell-offs. During times of high market uncertainty, it is not uncommon for there to be bans on short selling. This often occurs with financial stocks but could expand to include all equities. The irony is that by banning short-sellers you take away the only investor who absolutely must buy the stock (to cover his short). Any traditional (long) seller has no obligation to purchase the shares it sells back at a later date.
You can also short sell individual ETFs. By shorting the ETFs, you actually may benefit from the inherent risks associated with ETFs, namely 1- high concentration of the same securities within funds and 2- liquidity risks in the underlying. This strategy might work well for ETFs with a heavy concentration in a few stocks, like XLF. In August of 2015, we saw first hand, how highly concentrated ETFs act in a very volatile environment. When some of the underlying stocks were unable to open, it caused ETFs like XLF and QQQ to open dramatically lower. Also, the liquidity risks for all types of bonds are high in our opinion so it could also work for bond ETFs such as JNK.
Short-selling is generally not allowed in an IRA account, so it will have to be done either in a non-retirement brokerage account or in a self-directed IRA if the custodian allows it. It makes sense to know which self-directed IRAs allows short selling. We will keep readers updated on where you can short stocks to hedge your retirement nest egg. For non-retirement accounts, its good to know which online brokers offer the best services when it comes to short selling. These factors include borrowing costs and availability.
Important Point: Don’t confuse shorting an ETF (borrowing the ETF from your broker, selling it and buying it back or covering later) with a ‘short ETF’. A ‘short ETF’ is another name for an inverse ETF, along with ‘bear ETF’.