Putting on Risk in a Bear Market

Without a doubt the best opportunities present themselves during times of financial distress. During a bear market asset prices take to the downside as risk gets repriced and fear takes over. I would argue that the exact catalyst is not as particularly important as the archetype psychological response which it induces. Markets change, but the underlying emotions and behaviors of individual participants are as old as time.

Most of what holds us back in life is fear, and fear comes from the ego. The ego is an imaginary sense of self which requires constant confirmation and is very easily attacked. One insult can outweigh 1,000 compliments. The fear of looking like a failure, of being rejected, or of being “found out” all haunt us and keep us from achieving our true potential.

For an investor fear is deadly and leads to magnified loss. Fear usually takes three main forms: fear of losing money, fear of missing out, and fear of leaving money on the table. The market only presents probabilistic outcomes, so loss is a natural consequence of operating in this environment. Risk and reward are intrinsically linked, you cannot produce a return without taking risk. While many take risk, few accept the risks they take. An acceptance of risk means understanding that loss is possible and even likely.

Investing through a bear market presents many difficulties. Assets trade above their historical volatility and whipsawing action is painfully common. As the general market contracts so do most names, finding strength in broad weakness is often difficult and short lived.

Lowering your portfolio risk parameters, raising cash reserve and diversifying across non-correlated asset types can be a defensive way to navigate a bear market. However, there is a time and place to size up on risk and that time is usually during the all-is-lost moment. Putting on risk during these times can be daunting, by reducing the initial risk exposure and scaling into winners I have found that buying into strength can be profitable. However, time-frame analysis and measuring your risk through volatility based stops is everything. Additionally, exposure to non-equities can help reduce your overall portfolio beta.

As we navigate the next 18 months there will be plenty of opportunity to produce out-sized gains. By knowing our time-frames and measuring out the risk, investing in this market environment can be less emotional and more methodical.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s