Developing a buying policy for the bear market

Wealth warning. I only have a couple of years net accumulation ahead of me. You are most probably younger and have decades of accumulation. Do not extrapolate your situation from mine.

There’s a bear market on. Trouble with bear markets is that it’s tough to say where you are in it. Personally, I’m of the view this one ain’t got its boots on. Not only was the stock market pretty overvalued after a ten year bull run, but there’s also a genuine and unprecedented economic hit. In the UK if you aren’t deemed an essential biz, you ain’t trading. That’s a yes to the supermarkets and a no to Sports Direct, BA flights from London Gatwick and London City Airport, and tough trading if you are a cruise line. That’s a lot of economic activity switched off. It would be quite remarkable if this isn’t reflected in the stock market. Yes, it may look forward a year or so, but it’s not going to be like a three-month shutdown never happened. On the other hand, I am mindful of Anthony Bolton – don’t get more bearish as markets go down.

However, I’ve done my selling a  few weeks ago¹. Not gonna do any more of that, although of course my ISA is worth a bit less now than it was last year. Not 25% less, I’ve happy to say, which seems to be about the measure of the drop so far, but it’s taken a hit. I would not be surprised to see a market fall to 50% of January’s valuations, and at this stage there’s a lot of company financial results we just don’t know. If you’re Tesco you’ve probably done OK. Carnival Cruise lines, not so much.

Even some of what I hung on to, I shorted. I wasn’t going to sell ASL again, BTDT with Brexit. l But I have shorted the buggers for a couple of weeks. This is UK smaller companies, there is no end to the pain. Other than a fatter IG account. I shorted half of EDIN as well as selling half my stake.

drawdown or buying income

I hated the stock market last year, because I wanted to buy an income to top up my pension. It’s easy enough to live on and some fine living, but I have somewhere between two months and thirty years of more fine living to do.

Cash is king in a market crash and last year I had decided to drawdown a lump of cash over a few years to top up my income, roughly until when I get my State pension. I was going to add that to the income from my ISA, but that’s lower that it should be because of all the index stuff I have in it. My largest holding is VWRL, which pays²: a yield of  – drum roll – 1.98%

So I stuck that cash in Premium Bonds. You can’t  get any useful amount of interest on cash these days, and with premium bonds you don’t have to worry about the provider going bust³. The great thing about cash is that it’s defined, although in the case of the Great British Pound it’s not that well defined, because the pound has been going down the toilet since the Brexit stupidity, and is going down even more in this crash. That means inflation in the years to come.

Anyway, since I determined that drawdown policy last year it’s got overtaken by events somewhat. Exit bull market stage left, pursued by the mother of all bears.

What do I know?

I’ll start with what I think I know, bearing in mind Rummy’s theory of epistemology.

The markets are about 25% off earlier levels. If you look at VWRL

5 years of VWRL in Pounds Be aware that the Great British Pound is not an honest broker due to its tendency to go south relative to anything else of value. The hit is likely worse in real terms. We just aren’t aware of it yet.

the drop is there or thereabouts. The CAPE in the US is about 29 24 now, and VWRL is 50% US. There are/were arguments to tilt away from high CAPE markets, but a market can tolerate a high CAPE longer than you have patience. The market was therefore overvalued. It’s still pretty damn high

the Shiller CAPE ratio for the S&P500 which is about half the global index. For some reason the long-term average of 17-ish doesn’t show up for me here. Go get the original source for that

so there’s a decent argument to be made that the S&P is still overvalued. I’m using VWRL as a proxy for the market in general and it is my largest holding. You can see from the FT’s Markets at a glance that the chart of the FT All-world index is very close to the SP500. To a first approximation the S&P is the all-world, because it makes such a high chunk of the index.

Takeaway – at the moment the markets are better value than they were at the start of the year, but not outstanding value. Some aren’t as bad – there’s been so much bad news coming out of the UK since 2016 that the FTSE100 is good value at about 11, scaling UKVI’s computation for earlier this year. I’ve used his earnings value, but we can be pretty sure it’s not that good as earnings will be low this year. However, the CAPE averages over 10 years, so I won’t be more than 10% off.

I know that when I add money for next year and what I borrowed from my Charles Stanley ISA earlier this year I have about as much cash-like stuff in the ISA as shares – cash-like includes gold and bonds. I was holding about 25% in that before this crisis, but what I’ve sold and what I will add has topped it up. I am in a relatively good position now to make use of a bear market. Largely due to (cough) active decisions made a few weeks ago. That of course, is only any good if I get back into the market with those proceeds, and it’s only any real good if I launch some of the new ammunition into a market that is lower than it was in early March.

Time is of the essence to get into the market, on a scale of months and not years.

“Stocks go down much faster than they go up, but they go up much more than they go down.”

That one’s easy. A simple alert about 5% off the prices I sold at as an alarm saying

git yo’ ass back into the market, punk

will do. Yes, I risk being whipsawed into a bear market rally, but so far in needs at least a 10% rally⁴ before those alarms go off. Not unheard of, but not that likely IMO.

Bear markets are much shorter than bull markets. The falls are steeper. It doesn’t pay to hang around, getting back in.

Change in S&P 500 during bull and bear markets since 1970 Source

I need to be back in within a year, and I need to start now, even though I will track down some of the twisted wreckage, and rejoice that I held off over the last year’s overvaluations. There will be more losses, but I figure if I buy in through the rest of this year I will get a 30% discount compared to last year. Unless this bear market is like that late 1980s one.

What don’t I know

Everything else, but more particularly what sort of a hit the coronavirus shutdown will have on companies’ future earning streams. Although they have fallen, markets are saying this is no biggie, things will be back to normal in a couple of years. This is not the 1930s. Yet…

Combined with what I do know, I’m loath to conclude this a V shaped flash crash, even though when you look at VWRL

It could be a V-shaped hit, but seems to be still giving way

a v-shaped recovery is still possible. However, the lack of thrilling valuations and the almost full-spectrum shutdown make that less rather than more likely to my mind. Monevator is right when he says

Lower prices improve expected returns. All those markets everyone fretted were too expensive look a lot cheaper now. For example, Vanguard says the expected return from US shares over the next decade has improved by more than 50%, from 4.4% to 6.8% a year:

but CAPE indicates those US shares are less expensive, rather than cheap. Sure, the expected return is a lot better and there is a simple argument to steadily buy into the S&P every month from now on if your accumulation period is longer than 10 years. But the time to hang out this bunting is not yet IMO.

The fog of war is intense

There’s a limit to what you can draw from charts, because each and every stock market transient is an individual. In an earlier life before the millennium I was into technical analysis, and all that palaver. Let’s just say it didn’t end well. The Escape Artist says it all. When you see lots of courses telling you how great something like trading is, the question you gotta ask yourself is: if this is so damn good then why the hell are these guys pissing around telling other people how to do it rather than locking themselves into a darkened room and knocking it out of the park on their own behalf

But you have to become a wizened old mustelid before that is obvious, though I am happy to say that my younger self retained enough cynicism to eschew overpriced courses and stick with books. So I don’t bugger about with heads and shoulders, Fibonacci whatsits and so on. Some people may be able to make that work for them, I’m not one of them. The art of becoming a better investor seems to be one of elimination – learn what you can’t do, and stop doing it.

But we do know something about bear markets. This one started on the 19th February. The average S&P bear market lasts about a year, and recovery takes about two years.

That means if I am going to do something and get back in I want to have done most of it in six months and be back on my long-term asset allocation to equities by February next year, given I am adding new money to the market.

This is where I cocked up in the dotcom bust. Not necessarily in capitulating around 2002, but not getting back in. Well, until 2009, and that with all-new money 😉

Getting out in time is the easy part of the fight. Getting back in is the hard part.

Because you have to buy stuff that you know is going to go down in the near future. I will instruct Charles Stanley to start buying into the dev world ex UK index that I already carry in there and also to buy into a fund tracking the UK FTSE250. (ex investment companies, if I want to buy investment trusts I will do that myself) Many of these companies are going to go to the wall in the coming months and the FTSE 250 pays ‘owt as a dividend. This is going to get much worse before it gets better. I will do these two 50:50, and divide the cash I have in Charles Stanley into six parts for six months. And let them get on with it, CS has a regular investment scheme.

Update. Having now done this, for some reason that L&G fund of the FTSE250 ex investment trusts was an absolute bitch to find on CS. I’d come to believe it wasn’t available on there platform and had resigned myself to buying the HSBC FTSE 250 fund including investment trusts. But by listing fund managers:Legal and General I eventually found it. L&G is slightly less expensive at 0.22% as opposed to HSBC’s 0.5%, but let’s not sweat the small stuff. There be a great big bear steamroller coming behind these pennies, when I buy will matter a lot more than 0.3% difference in annual fees for a good few years yet.

I am therefore going to buy into the world ex UK, so well over half the S&P500. And UK tiddlers, that have taken no end of hurt due to the arrant stupidity of Brexit. Absolutely everything is wrong about the FTSE250 – pain in the past, pain in the future. I see no hope for these guys.

Which is why I am buying the buggers. Experience has shown me that I am not always right. Elephants don’t gallop, and this is a punt I can afford. I expect to hate myself for it in five years time… But if I do, the big fish of the S&P500 and a few other countries will make me feel better.

That will put back half of the value that I jumped out of the market. Not into the same assets – I shot everything that I didn’t love, and this will be into diversified index boring crap.

With the rest of my cash, and then some gold, I will try and make myself buy back into the market, with investment trusts at a discount. The premium/discount mechanism with investment trusts amplifies price movements, to your advantage as a seller in bull markets or a buyer in bear markets, and to your disadvantage as a seller in bear markets and buyer in bull markets. It also makes shorting these bad guys more interesting in a bear market 😉

Why investment trusts? I ain’t got 30 years of accumulation, where the slightly higher costs add up relative to passive funds. I want income rather than selling units, because I can never work out what and how much to sell, and it feels bad running down my capital at this stage. Income is going to be in desperately short supply over the next year. And it’s already clear that I don’t believe in passive investing, so I don’t have the angst associated with them. Oh and did I mention the discounts? As Monevator said

Discounts can be great for income investors, since the money you spend on your shares buys you more of the trust’s underlying income generating assets. For example, suppose a trust trading at £1 per share – the same as its NAV of 100p – owns a portfolio of blue chips that generates a 3% yield. If the share price falls to 90p to create a 10% discount to an unchanged NAV, then new buyers will enjoy a higher 3.33% yield from the trust. (i.e. 100/90*3).

There’s one small fly in the ointment. I have to make myself do it, in the face of a market that I expect to be screaming at me Wrong Way, Do Not Enter. I have to see the value of what I bought go down for months if not years. This could be a big one, like the runout of the dot-com crash, which was a grinding two-year slip-sliding away of market value. And I must not sell into that. I have seen this movie before, and I know that is tough. After I have managed to get the same amount of money into the market on manual as the Charles Stanley autopilot, I will have vindicated jumping out of the market earlier last month. If I managed to sell some gold and get further into the market, I have the potential to get ahead of myself, and vindicate my view over the last couple of years that the market was overvalued. But it ain’t gonna be easy, and I will only know I have won the fight in a couple of years when the market has recovered to the levels I sold out at.

a zoom out

And let us tip a hat to the dark times that have brought us to this sorry pass.  I would have cheered a bear market that resulted from a crisis of confidence that valuations are just too goddamned high, but not this one because of what caused it.

I may never get to look back from the sunlit uplands or never-ending recession that ensues. There is a slightly elevated risk that I will never see next summer, reminds me of this single⁵ from my schooldays in 1974, another long bear market during the oil crisis of the 1970s. For God’s sake don’t press play if you are feeling gloomy. They had to strike it from hospital radio playlists back then.

There are hopeful articles saying that the crisis will make people think a bit more about how they are living, and what really matters to them. It is possible, but we thought that at the fall of the Berlin Wall and ended up with thirty years of neoliberalism. This piece of the Wall that I picked up near the Brandenburg Gate when I went to Berlin the year afterward has proven more durable than those dreams

A piece of the Berlin Wall, picked out of the rubble by my younger and more idealistic self

We thought the world would change after 9/11, and it did. I’m not so sure for the better. There are big Spenglerian cycles as the West is surrendering its hegemony and the world becomes more multipolar and the power shifts to the East. But humans are adaptable blighters, and perhaps I am coloured by perspective. Even my cynical mustelid heart of darkness was cheered by people clapping for the NHS.

Of course my head tells me that there is now no effective medical assistance in the UK as it goes into the high-water mark of the pandemic. It’s not a criticism of the NHS and it’s not a criticism of political action or a lack of it. You can’t outrun an exponential, and throwing twice as much twice as fast buys you a lot less than you think.

But the recording is the result of a better use of social media than the ice bucket challenge. And perhaps when we look back on this we may believe less in rapacious managerialism for the NHS and perhaps not charge our trainee nurses student fees, living the values of our grandparents. Perhaps.

François Guizot, apparently

But the world belongs to the extraverted and the optimists. You need to be an optimist to invest into a bear market. I am not, but I can act that way. I think…

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1. It appears I jumped just before the formal announcement of a bear market. I could have done better, but I could have done worse. ↩
2. That should perhaps be paid a yield of 1.98%. I would guess dividend distributions will be a lot lower in the year to come ↩
3. Yeah, you can only put 50k into PBZ and theoretically you get £85k FSCS protection on deposits. But after hearing how long it took a family member to get his wedge out of Icesave I’m not having any truck with that sort of thing. Icesave was not FSCS guaranteed, but the interest rates on offer nowadays doesn’t justify the risk IMO. There is, of course, the other risk which has just risen which is the Cyprus bail-in style. You can’t outrun ’em all. ↩
4. It’s probably more than that. A quick eyeball of the percentages in a spreadsheet of what I sold give a typical 15% drop. To get from 85% to 100% is in fact an 18% lift on the current value. That will probably happen over the next two years, but it’s hard to see it happening in the next two months. ↩
5. I listened to this a lot in 1974, I had constructed a FM tuner out of modules, in those days impoverished kids with an engineering bent built HiFi because it wasn’t made in China for peanuts and cost loads. The damn thing hissed like a bag of cats because I hadn’t realised you needed signal strength for FM stereo and a T ribbon aerial wasn’t going to make it, even in sarf London. There was a lot of this track, though it’s really quite disturbing to see what poured into a young mustelid’s lugholes from the charts in ’74. ↩