Best Way to Invest in Bear Markets

5 min read

There is no worst feeling than sitting on cash while knowing that you could invest it when the markets were forming bottom but instead you chose to sit on the sidelines expecting stocks to dip further which never happened.

If you are sitting on a pile of cash and waiting for opportune moment to invest then this post speaks to you about the best investment strategy and rationale for its deployment in bear markets.

Investors’ Concern – Inflation & Interest Rates

In the current scenario, the investors’ concerns on stock markets can be distilled into two interconnected macroeconomic challenges: Rising Inflation (if you think it hasn’t peaked yet) and Rising Interest Rates (I doubt anyone today can doubt the likelihood of further rate hikes).

So let’s dive deeper into the two and assess how they impact stock markets.

It is a common knowledge that during inflationary periods, consumer staples often outperform consumer discretionary sector as customers start curbing their spending on non-essentials. Investors in general, also believe that companies margins get suppressed due to rising costs which in turn affect their profitability and valuations.

Yet, I would argue that the impact of inflation on corporates tend to be much less potent that believed otherwise.

You see companies find all sorts of reasons to jack up their prices in inflationary environment to maintain profit margins but guess what they do when inflation is on a downward trajectory?

You guessed it right, even in disinflationary environment, the prices stay elevated and if at all they eventually fall (due to competition), the downward move remains slow and sticky.

This practice adds to the margin of most industries that are capable to passing on their input costs to their customers (either fully or partially). So in reality, inflation may hurt consumers and bring down their spending propensity but it does not impact corporates’ profitability too much; mainly because the loss of volumes to some extent are offset by rise in margins (all else being equal).

Therefore, investors should never throw away their stocks fearing inflation because it rarely ever demolishes the future prospects of a good company.

On the other hand, rising interest rates indeed hurt both the profitability and valuations of corporates. Higher rates not only add to the direct interest cost of new and existing borrowings. But they also compell analysts to assign lower estimate to the fair value of a stock price because the companies’ future cash flow are valued at elevated interest rate levels (DCF Method).

So instead of rising inflation, investors must be more wary of rising interest rates.

Yet, in the grand scheme of things – neither inflation nor interest rates matter as much as we are made to believe by media and new channels. Because fall in rates is just as inevitable during economic slowdown as their rise during inflationary periods. Yes, the timing in the macroeconomic cycle can be a little off i.e., at times, one period stretches longer than the other but the change in cycle and rates direction is just as certain as death or taxes. In other words, neither the contractionary nor expansionary cycles are permanent.

As I covered in this video earlier, with each passing day spent in an expansionary cycle, we get closer to the contractionary cycle and the circle goes on.

At least we can all agree that it is not a matter of ‘if’, rather ‘when’ we will enter from tighter to looser monetary policy. While we all know that loose monetary policy invariably opens the door for the next bull run yet nobody can tell when the markets will make the switch from “sell, sell, sell” to “buy, buy, buy”.

Therefore, it is best that one follows a methodical strategy to enter the markets in a staggered manner.

Best Investment Strategy

Believe it or not, the best place to invest during high Inflation and Bear Market is still Stocks only.

However, trying to pick bottom on individual stocks can backfire as one can never know for sure how a company will perform in deteriorating economic environment.

So the best way to invest in falling markets is to put money in Index ETFs. Again, not just any index ETF but the headline index of the country/countries you invest in. So if you invest in US, then pick low cost S&P 500 ETF, NASDAQ 100 ETF, Dow Jones Industrial Average ETF.

Similarly, other countries’ headline indexes are outlined towards the end.

Rationale

The rationale for investing in such a way is that individual company can go bust (even the best of them can) but chances for a fundamentally strong country to go burst are almost negligible. And that makes investing in the headline country index a very safe investment. Not to mention the dividend you will receive upon investment, regardless of market conditions.

If you will invest 20% of your capital for every 2% drop during bear market, this will ensure methodical capital investments as the markets keep dipping lower.

Even more importantly, by investing in a staggered manner on every dip, you will have skin in the game. An abrupt end of bear market followed by the stocks’ rally will not leave you empty handed as you would have invested some if not all of your capital. And lastly, even in a bear market, you will feel good about both rallies as well as dips. Rallies will increase the Mark to Market returns in your portfolio and Dips will give you another opportunity to Buy even more at lower price. Either way, you WIN!!

Now here is the list of respective indexes you can invest in some of the major countries:

1. Australia: ASX 200
2. USA: Already covered above
3. UK: FTS 100
4. Germany: DAX 40
5. France: CAC 40
6. India: Nifty 50
7. Japan: Nikkei 225
8. China: A50 / HSI