These days just about everyone seems to be predicting a major market selloff. We know that bear markets are part of normal market dynamics and since the bull market is now 8 years old we have to be closer to the end than the beginning. Tactical strategies have gained in prominence since 2008 as investors love the idea of the ability to get market upside while limiting or eliminating market downside. Now, as we get closer to the end, investors are rightly asking the question “what happens to my strategy when the market crashes?”. They want to make sure that the promise of bear market protection is a reality and not a pipe dream.
To figure out what a tactical strategy is likely to do in a bear market you first have to determine whether the strategy is partially or fully tactical. Partially tactical strategies are basically asset allocation with some wiggle room. They can overweight or underweight different areas of the market but they never completely exit. These types of strategies can and should outperform the market during a downturn, but they will lose money. Fully tactical strategies have no fixed allocations, they can be 100% in stocks, bonds, or cash, or anything in between. There are a number of ways that fully tactical strategies can make money during a bear market.
- Move to cash and/or other safe haven assets: Fully tactical strategies can move to 100% cash and/or safe haven assets like Treasuries or gold. This gives these strategies the ability to at worst not lose money, and at best to make money as the safe haven assets increase in value. This is typically done with some sort of trend following or momentum approach. Simple strategies like selling stocks when they dip below a moving average or using a relative strength on a basket that includes stocks, cash, and some safe haven assets can all work well. These types of moves won’t make a lot of money in a bear market but being up 2% when the market is down 60% wouldn’t be that bad.
- Go Short: Some strategies have the ability to go short the market. This can be easily accomplished with ETFs again using some sort of momentum or trend following approach. Going short provides the opportunity for the strategy to make as much as the market is losing.
- Buy Volatility: In a bear market volatility will spike. There are ETFs that give investors the ability to bet on volatility so they can profit when it spikes. Typically, a volatility ETF will act like leveraged short exposure so less of a position is needed to protect a portfolio and/or to profit in a bear market. The advantage to this is that the strategy can stay more invested in stocks just in case.
- Buy Counter Trend Dips: Counter trend methodologies buy into weakness and sell into strength. In an up market buying the dips can almost be a license to print money. In a downturn the dips and the subsequent recoveries are much stronger. This creates some great opportunities when stocks get extremely oversold but also a ton of risk. Counter trend strategies should have state filters built in that make it harder to buy dips in a bear market than it would be to buy dips in a bull market.
As we get closer to the end of the bull market the era of easy money is coming to an end. Investors now need to be concerned about protecting the gains they have made over the past few years and making money in the next market downturn.