With all the renewed fears of a recession lately, it’s bound to get investors anxious. However, it’s important to remember that even the smartest of experts can’t predict the timing of the market, and furthermore, that most professionals will tell investors not to think about it and just ride out the storm.
It can be difficult to sit by and watch as the market crashes, and although I would advise not to do anything rash with your portfolio, there are steps investors can take to prepare their portfolio for the worst-case scenario.
Below are three ways to best position yourself for a bear market.
Although it’s certainly important that investors should never have too much cash, as the opportunity cost of holding that cash can be quite large, the opportunity cost of not having any cash in a bear market can also be devastating.
Investors need to find a balance that they feel comfortable with for emergencies and down markets. Having cash in bear markets can be extremely rewarding, but if you sell too many stocks too early, you may miss out on a lot of upside.
Long-term investors who regularly invest based on value will usually have adequate levels of cash. This is because as valuations rise over time and less value investment opportunities are available, cash will tend to build up in their portfolios from the sale of stocks and dividends.
A perfect example of this is looking at Warren Buffett’s portfolio. Over time, when he has a hard time finding a new investment, his cash position continues to add up.
The rise in valuations leads to a rise in his cash positions, which usually happens before a bear market. So when problems do arise, savvy investors like Buffett are well positioned.
A second way that investors can help position their portfolios are by owning defensive companies, or stocks with low betas.
If a stock market crash does happen and the economy goes into recession, these stocks will be better off because they have business operations that are less affected by the state of the economy.
Everybody needs to eat, whether or not they have tons of disposable income. For this reason, Loblaw will be less affected than most other businesses.
Looking back, last year from the beginning of October till the end of the December, the TSX lost around 10%, while Loblaw was up almost 15%. Loblaw also has a beta of just 0.26, showing that it is much less affected by the movement and direction of the market than many other stocks.
The trouble is buying it for cheap. Due to the ongoing worries about a recession around the corner, Loblaw and companies like it are trading at the top of their 52-week range, as investors bid up the prices while trying to get a piece of the company. It looks as though if fears persist, Loblaw could continue to gain well into 2020.
Reassess your portfolio
The last step to take is to assess your portfolio, and sell out of stocks you may think are overvalued.
While I don’t recommend going out and selling all your stocks and trying to predict a recession, I do recommend taking a good hard look at your portfolio every few months and reassessing each company individually. You may find a couple stocks you think are overvalued, and chances are they probably will be.
This would be a great time to sell these stocks and use the proceeds to build up your cash position or buy more defensive stocks.
This is important to do, even if you have no stocks you think are overvalued. The reason being, if a market crash does happen, you know all of your stocks have fair value and it will be much easier to keep your emotions in check. It’s common for investors to panic when they see red and sell impulsively.
By looking for overvalued stocks now, if you find none you will know in the back of your mind when everything is down, that it’s only temporary.
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Fool contributor Daniel Da Costa has no position in any of the stocks mentioned.