How to prepare for a bear market

  • Describe the background to the current bull market.
  • List how clients can prepare for a potential bear market when it comes.
  • Identify what type of companies will do well in a bear market and which to avoid.

The year that followed Mr Trump’s election was the best an American president had experienced in the markets since Franklin D Roosevelt won the presidency in 1945.

Of course, bull markets when they eventually strike, can be painful. But evidence suggests that recovery afterwards can be quick too – in the last two bear markets, global equities have recovered to their old highs in sterling terms within three years of the lows.

So, even if you timed an exit right, could you achieve re-entry with equal perspicacity?

2.     Do not ignore reinvested dividends

UK markets may have risen 25 per cent since their low, but if you include the dividend income you would have foregone as well, the figure is closer to 37 per cent.

People often forget to take into account dividends when measuring performance up or down. And that means they underestimate the power of reinvested dividend income to soften the blow of an equity market crash.

Just because share prices have taken a hit, it does not mean that the companies themselves are not still working hard, generating profit and redistributing it.

3.     Focus on value not valuation

If you have decided that your clients need to remain on the road and invested there is still much your chosen investment manager can do to protect them from whiplash.

The most important is to focus on valuation.

Some stocks become particularly loved. Investors can get caught up with a great story and start buying the hype – valuations run ahead of value.

A prudent manager watches the numbers and when something falls outside their valuation parameters or they have no clear way of confidently working out what it is worth, they have the courage to sell.

Sitting on a stock with a silly valuation is risky.

From experience, I can tell you that selling it can make you feel silly at the time, but you will seldom regret it in the long term.

Vodafone amply illustrates this. In February 2000 Vodafone shares were being traded at 505p. It was a FTSE darling to many investment managers.

If you had said it was expensive, they would have readily agreed, but said: “It’s big and it keeps going up.” They were afraid of missing out by not holding it.

In the tech crash soon afterwards, Vodafone lost nearly 75 per cent of its value.

Its year high is still under £2 and it is currently trading at around £1.27. We have just bought it. Why?

4.     Include some cockroach stocks

It is difficult to imagine that Vodafone was once like Amazon and Apple – a tech darling.

Today it is what we call a cockroach stock – the sort of stock that can survive the worst of storms.