How to adjust your portfolio in bull and bear markets?

This is because most investors are essentially long in the markets. The bigger question is whether you can adjust your portfolio to such market conditions?

Sep 16, 2018 06:09 IST India Infoline News Service

How do we define bull and bear markets? There are various definitions of bull and bear markets with the most popular definition being the 20% upmove or the 20% downmove rule. A consistent rise of 20% or more is a bull market, while a consistent fall of 20% or more signals a bear market. Obviously, bull markets are synonymous with price appreciation and wealth creation, while bear markets are synonymous with portfolio losses and value destruction. This is because most investors are essentially long in the markets. The bigger question is whether you can adjust your portfolio to such market conditions? Let us look at three such adjustments.
  • Adjustments to be made in a Bull Market
  • Adjustments to be made in a Bear market
  • Adjustments to be made in All Markets
 
Adjustments to be made in a Bull Market
Even within bull markets, there are temporary bull markets and there are structural bull markets. For example, what the Indian markets saw in 1992 and 1991 were temporary bull markets, whereas the bull market from 2003 to 2008 was more structural in nature. Here are some basic adjustments that you can consider.
  • In a structural bull market, you need to ensure that you are over-invested in equities. What does that mean? If you have an allocation of 55-65% in equities, then ensure that you are closer to the higher end of the range.
  • As part of your portfolio strategy, you must use such bull markets to drag the momentum in your favour. Don’t be in a hurry to book profits. Hold on to your profits as long as possible. and if required. take the help of trailing stop losses. On an average, bull markets have lasted ~6 years in the last 28 years. The onus is therefore on you to make hay while the sun shines.
  • Your basic strategy should be a long-side strategy. Just because the markets have risen or valuations are above 25X P/E, don’t try and sell into the market. Your approach can either be “buy with momentum” or “buy on dips”.
  • Focus on mid caps in the early and middle stages of the bull market, but shift to blue chips in the later stages of the bull market. When the market valuations go beyond previous highs and there are macro headwinds, you can take an approach to lighten your equity positions.
 
Adjustments to be made in a Bear Market
  • Strategies in a bear market are a lot more complicated because most investors are more attuned to operating in an environment where prices are going up. In a bear market, liquidity is king. Ensure that you are largely shifted into bonds, liquid funds and cash, even if it translates to losses. This liquidity helps you to buy your favourite stocks at lower levels. Not having liquidity is the biggest opportunity cost in bear markets.
  • Adopt a phased approach when you are buying into bear markets. Sharp bear markets rarely show V-shaped recovery. They tend to stagnate for a long term, consolidate at lower levels and squeeze out the bulls before bouncing back again. This means that if you have a target to buy your favourite stock, try and phase it out over a few months so that you get the best levels possible.
  • Stay away from the stocks that triggered the bull markets in the previous phase. For example, if you see 1992, 1999 and 2008, it was cement, software, infrastructure and realty stocks that saw the maximum erosion. When a bear market follows a bull market, make it a point to stay off previous bull market triggers. They are unlikely to hold value.
  • Bet on the defensives. Even if you look at the carnage of 2000 or 2008, you will see that defensive sectors such as FMCG and pharma, managed to hold value much better than the typical cyclical stocks. Nobody reduces their equity portfolio to zero because conditions are bearish. So, the question is which stocks should one hold on to in a bear market? The answer is to hold on to very defensive sectors, which will anyway see buying interest in the midst of the cyclical correction in stock prices.
  • This is the time to make the best of hedges using futures and options. When markets become bearish, they normally lead to an increase in volatility. By using put options, you not only hedge your downside risk but also make money when the markets go downward. Option values will get the double benefit of falling prices and rising volatility. This is an important tool to be used in bearish markets.

Finally, that one strategy to be used in all markets
A common complaint of most investors is that by the time the bull market or bear market is identified, the damage to the portfolio is done and the risk appears to be too high. How can one address this issue? After all, it is a very practical issue faced by investors and traders alike. The answer could lie in a more allocation-based approach to stock markets. Here is how it will work.

Your starting point is normally your financial plan where you make allocations to equity, debt, gold, liquid assets, etc. Normally, when you define the range you also define the outliers of the range. What exactly is an outlier? If you allocate 60% to equities, then you can set a trigger that 70% will be an outlier. When equity exposure touches 70% you automatically reallocate the profits to debt so that the original allocation mix is maintained. This is a passive approach but can work beautifully for handling the vagaries of bulls and bears.

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