Last month, the US economy entered the tenth year of the current period of economic growth. It’s now the second-longest period of expansion in history and so the question is, of course, ‘how long can it last?’
The end of the current bull market doesn’t appear imminent and could continue for months or even years. However, as economic indicators start to point to a slowdown, it’s important that you’re prepared if markets do turn.
When is a bear market likely to occur?
While there is no direct link between a recession and an equity market downturn, there is a close relationship in advanced economies.
Between the 1929 Wall Street crash and the global financial crisis of 2008, there were ten bear markets – periods when global equity markets declined by more than 20% from peak to trough – and only two of these (the flash crash of 1962 and 1987’s Black Monday crash) were not accompanied by a recession.
So, if indicators start to show that manufacturing is falling, inflation is rising, or interest rates begin to creep up, then it’s possible that a recession is on the way.
Right now, there is little convincing data that a downturn is imminent, although PMI surveys which measure firms’ expectations about whether business is speeding up or slowing down have reached recent lows in China, the UK and the Eurozone.
What we do know is that a bear market will occur at some point. So, what can you do to prepare? Here are seven tips:
1. Don’t panic
If markets begin to wobble, remember the old phrase ‘time in the market, not timing the market’. Refusing to panic and staying calm is key.
Trying to avoid downturns in the market can end up costing you more than sitting through a bear market itself. For example, in the first hour after the Brexit referendum result was declared, the FTSE fell almost 8%. Since then, the index has risen by almost 25%.
Similarly, markets in the US tumbled in the immediate aftermath of the election of Donald Trump in November 2016. Since then, the Dow Jones has risen by 45%.
2. Pick the ‘cockroach’ shares
Cockroach shares are those which can survive even the most apocalyptic of storms. It’s important to have some of these equities in your portfolio as, even in a downturn, the company should still make money.
A good example is Vodafone. Mobile phones are an essential for most people and so even in a tough market, it’s a company that should continue to generate a decent yield.
While it is nice to have some more glamorous holdings in your portfolio, you need these trusty investments too.
Which leads us to…
3. Look for companies that can survive in difficult times
If a bear market is coming, look for companies that can continue to flourish in difficult times. Perhaps they have a well-known global brand or technology that puts them ahead of their competitors? Maybe they have little or no competition? Or can they raise their prices if inflation begins to bite?
On the flip side, avoid companies who might struggle in a downturn – for example, travel agents or housebuilders.
4. Don’t leave yourself over-exposed
Diversification is another way that you can insulate yourself against any downturn. For example, if you only hold 2% in any one company, it’s not the end of the world for your portfolio if they really struggle in a recession.
Every company can experience a sudden shock – a high-profile resignation, allegations of wrongdoing, a PR crisis or even the wrath of a politician – so ensuring you don’t put all your eggs in that basket can help you to minimise your exposure to these issues.
5. Hold some cash
There are several good reasons to hold part of your investments in cash:
- It shields your money against stock market falls
- You keep an ‘emergency fund’ to meet short-term expenses if your circumstances suddenly change
- You have liquid capital available to buy shares at knockdown prices if the market falls.
Of course, the problem with holding cash is that you’ll generally get a low return compared to other investments.
According to the Barclays Equity Gilt study, an investment of £100 in the UK stock market in 1945 would have been worth £179,695 by 2015 with dividends reinvested, compared to £6,261 if saved in cash.
6. Consider widening your investment horizons
Even though the UK represents less than 6% of the MSCI Global Index, many investors still have the majority of their equity holdings in UK companies.
While there are arguments for holding UK shares – many companies listed on the FTSE are global organisations, it reduces currency risk – holding predominantly British shares can mean you miss out on excellent growth opportunities elsewhere.
7. Remember reinvested dividends
The UK stock market may have risen almost 25% since the EU referendum, but if you include the dividend income you would have foregone as well by exiting the market that day, the figure is closer to 37%.
Investors often forget to take dividends into account when measuring performance up or down. If you do this, you underestimate the power of reinvested dividend income to soften the blow of a stock market downturn.
Just because share prices have taken a hit, it does not mean that the companies themselves are not still working hard, generating profit and redistributing it.
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The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.