The US stock market officially entered bear territory in 2022 when major US indexes saw brutal dips; the S&P 500 oscillated in and out of bear market and is expected to drop further in 2023. The Nasdaq Composite also fell below 30% in 2022, and the Dow Jones Industrial Average plummeted by more than 3,800 points. Mounting concerns of a recession have continued in 2023, as inflation remains high and interest rates continue to climb. We have also seen more evidence pointing to even tougher economic conditions ahead as the US Federal Reserve continues to hike interest rates to cool off the labour market.

Bear markets can be challenging for most investors, with many resorting to short selling as pessimism looms and new headlines cause everyone to panic. To really survive an economic recession, it is essential to be strategic and avoid a sudden flight-or-fight reaction. And while you shouldn’t expect any significant profits from any sector during this season, there are effective strategies to help you hedge your assets against huge losses.

How to Tell When a Bear Market is Near

The first step in surviving a bear market is to look for certain financial events that strongly indicate when a bear market is impending. 

A bear market is defined as a widespread decline of asset prices by 20% from recent highs. However, if you have to wait until the stock market falls to understand that the economy is headed into a recession, then you may be looking at a huge loss. Instead, it is important to be aware of economic cycles at any given time and prepare your portfolio to defend against the economic turn.

Rising Federal Funds Rates

The stock market is highly sensitive to the federal funds rate. This is because the cost of borrowing plays a critical role in the economy, as it determines the availability of investment capital for businesses, as well as the cash flow needed for consumer spending. Rising federal rates slow down economic activities due to higher borrowing costs, which signal a downturn in business profitability or margins and the resultant stock value.

Inverted Yield Curve

A yield curve is a graph representing the difference in returns between debt instruments such as bonds with equal credit quality but varying maturities. When the yield curve shows falling returns for bonds with future maturity dates, it is called an inverted yield curve or a negative yield curve. This market situation happens when the purchase prices for bonds are bid up due to higher demand by investors. With a higher face value, the yield on a bond will drop as the coupon rate for a bond is always fixed regardless of the current trading price. Inverted yield curve has proven to be a strong signal of a looming recession, this is because when market prospects become uncertain, investors move away from more volatile assets like stocks to risk-free investments like T-bills and bonds, hence the rise in demand.

Source: Bespoke Investment Group 

Sector Rotation

Market sectors respond differently to an economic slowdown. As prices peak and cash flow becomes tight, consumer confidence starts to falter due to worries about the state of the economy and their own finances. The result is a change in consumer spending priorities. For investors, it can be helpful to monitor sectors in the stock market that are performing in order to understand how close a bear market might be. Usually, inflation-sensitive sectors like finance, consumer discretionary, or real estate tend to be the first affected by a recessionary climate, although they also are the first sectors to outperform when the economy begins to recover. On the other hand, sectors that cater to basic consumer needs like consumer staples, utilities, healthcare, and energy are more inflation-resistant and remain stable across all phases of the economic cycle including recession.

Market Correction Vs Bear Market

Like bear markets, market corrections is also another term used to describe falling stock prices. However, they are not the same. A correction is defined as when stocks or indices decline between 10% to 20% from their recent highs within a duration of less than two months. The scale of decline for bear markets however starts at 20% and lasts for months, years, and even decades. 

It is common to see a market correction more frequently, as it occurs as a result of an external crisis or a temporary economic shock that prompts investors to sell or pause buying. In contrast, a bear market is usually the result of a slowing or sluggish economy, significant economic shifts, geopolitical crises, or national and global events.

Strategies for Investing in a Bear Market

While it may seem counterintuitive to invest amidst falling stock prices, the goal of investing during a bear market  isn’t to make massive profits. Instead, focus on strategies that can help you hedge against loss or position yourself for the long term, because every bear market will eventually be over.

Defensive Stocks

Defensive stocks have a stable performance regardless of the overall state of the stock market. This is because they are part of sectors like consumer staples, healthcare, and utilities that enjoy constant consumer demand despite economic conditions. Defensive stocks can help you hedge your portfolio during a recession. However, it is important to understand that rushing into defensive stocks too early in the economic cycle can lower your returns.

Long-term Buying

The bear market can be a great time to lock down high-value stocks at very low prices. As recession looms, it is wise to hunt for highly promising stocks and companies with strong fundamentals as long-term options for your portfolio. If you can wait patiently through the scary market dips, the reward can be significantly great when the market bounces and your stock value skyrockets. 

Cash & Liquid Assets

A cash stash isn’t a bad idea in a bear market. While cash is unlikely to bring in much profit, buying money market securities like treasury bills and bonds can protect your money against rising inflation. Additionally, having enough cash at hand can prepare you to take advantage of high-growth stocks as soon as the market starts to recover.

Dollar Cost Averaging

Dollar cost averaging is a way to minimise market risk when investing during uncertain times. It involves investing a small fixed dollar amount at intervals in a specific security over a period of time, regardless of their current price. This strategy allows you to spread out the accumulation of a target asset over a length of time without committing to a large purchase all at once.

Zero in on the Best Opportunities in the Bear Market With Anahit

With in-depth investment analysis tools from Anahit, you can look beyond falling asset prices and bear market headlines to identify strategic opportunities for your portfolio as the stock market prepares for recession. Anahit’s five-dimensional analysis allows you can compare sector performance, research the fundamentals of target securities, and keep your finger on the market’s pulse by analysing news headlines and social conversations.

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