8 Places To Park Capital If Markets Tumble

In 2022, the S&P 500 fell by approximately 20% but it reclaimed most of those losses in 2023 by soaring 25%.

If the math doesn’t seem intuitive at first, just think about a $1,000 portfolio dropping by 20% to $800. In order to rise back to $1,000 it must go up by $200 (and $200 divided by $800 is 25%).

Now that the S&P 500 is back to levels reached a couple of years ago, astute investors are eyeing where to allocate capital if another downturn hits.

What To Invest In When Markets Fall

Volatility based instruments are an attractive option when markets fall because they are purpose-built to capitalize on heightened market turbulence.

When a correction, or worse a bear market hits, these volatility instruments can be particularly lucrative by themselves or as part of a hedging mechanism.

One example of such an instrument is a put option that benefits not only as share prices decline but also as volatility rises. Volatility index funds can also do well, such as those linked to the VIX, or Volatility Index. 

Tail Risk Hedging

Another popular strategy employed by the likes of Nassim Taleb includes tail risk hedging. His approach at Universa is to hedge for tail risk at all times rather than to predict black swan events, which definitionally come out of nowhere. 

The strategy doesn’t seem very effective for long time periods but eventually pays off in a big way if and when a market crash occurs because the outsized gains offset the slow drip of steady losses.

In many ways it’s akin to buying insurance on a home or automobile because it’s only useful when something bad happens but it costs money every step of the way.

Defensive Stocks

Defensive stocks are a popular play when markets plateau and start to turn downward also.

These typically feature a combination of healthcare, consumer staples and utilities. The idea being that in times of upheaval, consumers and businesses still pay for essential services like water and electricity, as well as staples like food and hygiene products.

While they don’t offer the growth potential of cyclical stocks, the stability provided in conjunction with their dividends, provides a stability that portfolios benefit from during times of economic turbulence.

Counter-Cyclical Assets

In the same vein, counter-cyclical assets gain in popularity during market plunges because they have an inverse relationship with the general economy, and often rise in value as markets fall.

Arguably the most well-known counter-cyclical asset is gold, which is regarded both as a store of value and a hedge against inflation and currency devaluation. 

Some commodities like precious metals and even agricultural ones act counter-cyclically due to their inherent value or supply-demand dynamics independent of economic cycles.

Fixed Income Securities

Turning our attention away from the equity space for a moment, fixed-income securities are viewed as a safe haven in times of strife, particularly high quality bonds that feature fixed income and lower risk levels. 

When markets are falling, the stability of fixed-income securities grows and offers reassurance that cannot be found in equity markets.

High-grade corporate bonds are another popular alternative that offer a steady income stream and are less susceptible to market fluctuations when compared to stocks.

Cash & Cash Equivalents

Similarly, cash and cash equivalents, such as money market funds, short-term government bonds and Treasury bills, are renowned as a defensive strategy during bear markets. They also offer enormous optionality when it comes time to enter risk assets again. 

While cash generally won’t produced a high return on capital, the return of capital is prized during downturns. Scooping up undervalued assets at lower prices leads to higher returns over the long-term.

Short Positions

While liquid reserves protect capital when asset prices are falling, short positions directly benefit from declining prices.

This requires borrowing an asset and selling it with the expectation that markets will fall further and with the aim of repurchasing the assets at lower prices, and subsequently returning the borrowed shares while pocketing the difference.

When the tide goes out and markets fall, shorting is often very rewarding because assets tend to fall in tandem but beware that sharp snapback rallies have shaved the portfolios of many a greedy bear.

Value Investing

Finally, value investing is the approach that Warren Buffett typically employs during bear markets.

He waits for prices to fall to levels where the market capitalizations of enterprises sit well below the companies’ intrinsic net worths and then buys them in anticipation of a rebound over the medium to long-term.

These stocks will typically have a combination of strong fundamentals, such as earnings, dividends, and balance sheets, as well as poor sentiment leading to an overreaction to the downside.

The significant upside potential is realized usually after fear has dissipated in the markets, and a bullish uptrend has resumed.

How To Invest When Markets Top

The best ways to invest when markets top include volatility based instruments, tail-risk hedging, and short positions. Other popular strategies employed by wealthy investors, like Warren Buffett, include value investing, exposure to cash and cash equivalents, buying counter-cyclical assets, and fixed income securities.

Generally, the best approach for ordinary investors is a combination of these strategies, particularly boosting cash levels and liquid reserves and buying both government and corporate bonds. Reducing exposure to equities is typically the smart move also.

Thereafter, value investing and allocating capital to counter-cyclical and defensive stocks is prudent.

More nuanced strategies, such as tail-risk hedging and gaining exposure to volatility based instruments can then be employed.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.