How should one invest in a bear market?

May 31, 2016 | By Fitz | Filed in: Investing.

The stock market is falling, and I’m afraid to invest because everything is going down. What’s the strategy when it’s a bear market? Should I avoid investing? Or should I buy now because prices are low?


This is a superb question because there are a lot of misconceptions out there about true value investing and how to prudently navigate a bear market.

The biggest mistake that “would-be” value investors make is oversimplifying the words of Warren Buffett, Howard Marks, and the like, and thinking that investing in a bear market is as simple as aggressively going long anything and everything that screens cheap.

It is a mistake to think that a bear market makes investments cheap. Rather, a bear market makes investments mispriced.

Don’t get me wrong – in many instances bear markets do precipitate dislocations to the downside, and some of the greatest investment opportunities arise from companies for which the market has an unwarrantedly negative view.

But identifying these opportunities is difficult because there are often just as many mispricings to the upside as well. The market generally isn’t stupid, and for the vast majority of investments that have declined 90% in price, there is a damn good reason for that decline – most of them are actually worth zero.

As an investor, my job is pretty simple – to distinguish which mispricings are which. The reason I like bear markets isn’t because it allows me to take the shotgun approach of investing in everything that screens cheap.

Most of the time this approach ends in disaster (remember that just because something has fallen by 90% doesn’t mean that it can’t fall by another 90%). Rather, it’s because irrationality peaks in bear markets and the market becomes less efficient.

Most of the time I consider myself lucky if I can find 2 or 3 compelling investment opportunities per year. In a bear market, these dislocations just tend to be more plentiful.

So how should one invest in a bear market? With caution. Don’t view it as a once in a lifetime sale. Rather, imagine that you went to the grocery market and some incompetent employee shifted all of the price tags around to different products.

It doesn’t mean that you should automatically go around and buy all the produce. Rather, just buy the ones where intrinsic value is very clearly above the sticker price.

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