What Do Investors Do During A Bear Market?

Certainly, the rate of inflation has slowed slightly since June’s 40-year high, but the relief was primarily due to a minor drop in gas prices. The recent news from OPEC+ that production will be trimmed by two million barrels per day beginning in November has already erased some of the reduction in gas prices.

Unless OPEC+ can be prevailed upon to reconsider the plan to reduce oil production, gas prices will continue to trend up. That means more inflation, higher interest rates, and continued pain for consumers and investors. Some experts suggest that the bear market will develop into a full-blown recession, and the economy will get worse before it gets better.

What Happens To Stocks During A Bear Market?

The gloomy economic forecast makes investing more difficult because many companies will lose value as the bear market drags on. They will struggle even more in a recession. Growth stocks have been hardest hit as investors flee high-risk securities in favor of safer value stocks.

That puts growth investors in a predicament. Growth strategies differ from value strategies quite a bit, and the criteria used to select promising growth stocks aren’t the same as those used in value investing.

Investors who are moving from a growth strategy to a value strategy or attempting to optimize a value portfolio have one burning question: how do value investors invest in a bear market?

Should You Invest In A Bear Market?

Warren Buffett and Peter Lynch have well over a century of investing experience between them, and both are known for their adherence to the principles of value investing.

Over the course of their lengthy careers, they have delivered profits to shareholders through market highs and lows. They have survived – even thrived – as the economic cycle repeatedly played out. That’s why the smartest investors are turning to Buffett and Lynch for advice on managing through these uncertain economic times.

Warren Buffett: Advice For Investing In A Bear Market

The global financial crisis of 2009 sparked what has come to be called The Great Recession in the United States. Investors watched the value of their portfolios plummet, and financial advisors scrambled to shift funds into safer assets.

However, while other experienced investors panicked, Warren Buffett stayed calm. He reminded investors that market downturns can bring tremendous opportunities. During this period, he published a New York Times op-ed that included one of the most famous Warren Buffett quotes: Be fearful when others are greedy, and be greedy when others are fearful.

In other words, Buffett said that bear markets are the best time to buy quality stocks at rock-bottom prices – but the key is to define “quality” very carefully.

Now isn’t the time to gamble on questionable startups and struggling growth companies. It’s the time to load up on shares of companies in strong competitive positions – the ones that can survive an economic downturn and emerge intact on the other side.

Buffett’s advice is meant for investors who have the patience and discipline to build a portfolio for the long term. There is sure to be more volatility over the next 12 months – perhaps longer – so rewards may not come for years.

However, with the right stocks – for example, companies like Amazon, Coca-Cola, Mastercard, and U.S. Bancorp – and an extended investment horizon, value investors can relax regardless of whether or not interest rates go up further, inflation rises, or the bottom drops out of the market.

Peter Lynch: Advice For Investing In A Bear Market

Peter Lynch might not have quite as many years of experience as Warren Buffett, but he is no less an expert. In fact, he launched a very successful financial services career during conditions similar to those in play today.

From 1977 to 1990, Lynch managed Fidelity’s Magellan Fund. He made a name for himself by delivering annualized returns of nearly 30 percent, despite disruption to oil supplies and extreme oil prices, disastrously high inflation, and Federal Funds rates above 19 percent.

One of the most often repeated Peter Lynch quotes is nearly identical to Warren Buffett’s advice, “be greedy when others are fearful.” Lynch said, “A correction is a wonderful opportunity to buy your favorite companies at a bargain price.”

How To Choose Stocks In A Bear Market

In short, Buffett and Lynch agree that the best time to buy stocks is during a bear market. Of course, standard rules for choosing high-quality stocks still apply. Warren Buffett’s strategy includes asking these questions:

• What is the company’s historical return on equity (ROE)? How does that compare to its competitors? This speaks to the company’s performance.
• How much debt has the company taken on? A large debt-to-equity ratio is a reason to rethink buying shares. Among other issues, this indicates that the company is overspending on interest instead of reinvesting in growth or returning profits to shareholders.
• How are profit margins trending? Large profit margins are obviously better than small ones, but it is critical to review profit margins over time. An upward trend speaks to tight control over operating costs and generally solid financial management.
• Does the company have a moat? It goes without saying that no business can continue to be profitable if competitors capture too much of its market share.

The final question sets value investors apart from the pack: is the stock trading at a discount to fair value?

Warren Buffett is famous for identifying undervalued companies and buying up shares before the rest of the market catches on to the organization’s true intrinsic value.

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