Investing during a market downturn often sees sophisticated investors, sometimes referred to as “smart money,” making strategic moves to capitalize on potentially undervalued assets and manage risk. One common approach is to focus on companies with strong underlying fundamentals. These include solid balance sheets, consistent profitability, and reliable cash flow. Companies with stock prices that have declined due to broader market sentiment rather than company-specific issues. These investors look for intrinsic value and are willing to hold through short-term volatility for long-term gains.
How to start
A smart tactic involves a more measured approach to “buying the dip.” Rather than aggressively buying all at once, smart money might incrementally add to their positions in high-quality assets as prices fall. Thus averaging their cost and mitigating the risk of buying too early before further declines. Increasing cash reserves is also a prudent move during uncertain times, providing flexibility to deploy capital when truly attractive opportunities emerge and offering a buffer against further market weakness.
Portfolio rebalancing is another key strategy. A market downturn can skew asset allocations, for example, reducing the proportion of equities in a portfolio. Smart investors use this as an opportunity to sell some of their better-performing assets, like bonds, which may hold up better during a stock market decline. Then, they buy more of the now cheaper assets and stocks, bringing their portfolio back to its target risk levels and potentially benefiting from the eventual recovery.
Certain sectors tend to be more resilient during economic downturns, such as consumer staples, utilities, and healthcare. Smart money might increase exposure to these defensive sectors for greater stability. High-quality government bonds are also often sought as safe-haven assets during turbulent times, offering relative security and potential for capital appreciation if demand increases.
A safe stock to watch
While requiring specialized knowledge, some sophisticated investors may cautiously explore alternative investments like gold or certain segments of real estate as a hedge against market volatility. Dividend-paying stocks like Fortis (TSX:FTS) can become more attractive during downturns, as the dividends provide a steady stream of income even if the stock price remains stagnant, offering a layer of downside protection. In some cases, convertible securities, which blend features of bonds and stocks, might also be considered for a balance of income and growth potential.
Identifying where smart money is moving can involve observing indicators like insider buying. For instance, if Fortis executives were to buy shares during a dip, that might signal internal confidence in the company’s long-term strength. Other signs include institutional ownership increases, often found in quarterly filings, and valuation shifts. These include declining price-to-earnings (P/E) or price-to-book (P/B) ratios.
Fortis, for example, has historically traded at a premium due to its stability. In the last trailing 12 months, Fortis stock traded at 20.23 P/E. This is higher than the last few quarters and, indeed, has been rising, climbing from about 17 P/E over the last year. A lower-than-usual P/E ratio during a market downturn could flag a potentially attractive entry point. So, should the P/E fall to that trailing 12-month figure at 17 or lower, it could be a sign to pick up the stock.
Bottom line
It’s crucial to remember that any investment decision should align with your risk tolerance, time horizon, and financial objectives. Just because a stock’s price is falling doesn’t mean it’s a bargain. Due diligence remains essential. Smart money typically plays the long game and understands that diversification across asset classes and sectors is one of the most effective ways to manage risk over time.
