As an investor in the equity markets, it is natural to feel elation at rising share prices. We all feel wealthier – at least on paper. As fund managers, we understand that prices fluctuate far more widely than values. Rather than despairing over falling prices, we fund mangers see them as long-term buying opportunities.
The term “bear market” describes a period of depressed or falling security prices. Bear markets are characterised by periods of lower global liquidity, rising inflation, rising interest rates, negative earnings news and resulting negative sentiment. They are often cyclical but are typically shorter than the average bull market. It is my belief that we are at present firmly in a bear market, and have been so since early in the year.
It is important that our customers understand that bear markets are not all bad for long-term investors. They provide opportunities to buy shares in good companies at great prices and often in large volumes. This is because markets are less efficient during bear phases as many market participants are selling for reasons that are unrelated to valuation, such as to reduce gearing or to raise liquidity. Buyers of shares can therefore pick up bargains.
In our experience, we have found it particularly valuable to identify a bear market early on in its cycle. Early identification provides an opportunity to position client portfolios defensively for the duration of the bear market before restructuring becomes impossible. The restructuring of client portfolios in the early stages of a bear market includes raising an appropriate cash balance to buy equities when they become sufficiently cheap.
Aside from the pure defensive positioning of the portfolio, it is also important that the securities held will participate in the pick-up when the bear phase ends. It is therefore paramount to ensure that the portfolios hold companies that will not only survive, but which will continue to grow their earnings at above average rates when the economy once more gathers pace.
Financial markets lead the real economy by many months and so the end of the equity bear market will precede an improvement in fundamentals. But investors shouldn’t underestimate the power of sentiment, which can be most negative towards the end of the cycle. It is during these final stages of a bear market that the best bargain purchases can be made.
I often remind investors that all bear markets eventually end. Sometimes this is difficult to envisage in the turmoil of market corrections. This bear market, too, will end, and likely sooner than most people expect. It is immensely important that you are invested when the turning point comes.
Brian Davey is Director and Portfolio Manager at Foord Asset Management.