Tuesday, March 10, 2009

Surviving a bear market

Though there is no clear definition of a bear market, in India such phases have lasted anywhere from 56 weeks to 84 weeks, with the market losing between 41% and 57% from the peak levels. Here are some ways to survive the meltdown.
Non-equity investments
With equity losing steam, investors are looking to park their money in cash, fixed deposits and real estate. Among these, cash is the favoured option despite the low returns that it offers. Though some may look at gold as an alternate investment, it does not have any correlation with equities and should be an investment irrespective of the direction the market takes. Here is what the non-equity options offer and the things that one must keep in mind while investing in them.
Cash
Safe haven in short term.
Returns from cash and cash equivalents are very low.
Cash funds are generally safe, but during the credit crunch of 2008, even they felt the heat.
Remember
Falling interest rates affect returns.
Cash funds carry a credit risk.
Rising inflation reduces the value of the cash holding.
Property
Falling interest rates mean cheaper borrowing.
Rentals provide steady source of income.
Less risky than equities, but more risky than FDs.
Remember
Property prices could be as volatile as equities.
High prices mean that rental yields are very low.
Difficult to sell quickly.
Fixed deposits
Low-risk option.
Provide steady source of income.
Diverse options and maturities:
- Govt bonds, bank or corporate FDs
- Short-, medium- and long-term
Remember
If interest rates rise, investor loses out.
It's best to invest in bonds of varying terms.
There's a credit risk if bank or company goes bust.
Inflation eats into the value of investment.
Equity investing strategy in bear markets
Having suffered heavy losses in stocks, many investors want to keep off equities. But there are ways in which you can invest in stocks with minimal risk. Investing in dividend yield stocks, defensive sectors and funds with holdings across market capitalisations can help make money in a volatile market.
Dividend yield stocks
Depressed share prices push up dividend yields.
Dividends can compensate for the fall in share prices.
The dividend yield acts as a cushion, preventing the share price to fall beyond a point.
Remember
Dividends and payout ratio are not guaranteed.
Very high dividend yield could be because the share price has been beaten down.
Rising interest rates make bonds more attractive because they carry less risk.
Defensive sectors
Some sectors fare better during bear markets:
-Utilities
-Pharmaceutical
-Oil companies
-FMCG, tobacco manufacturers
Utility companies pay generous dividends, which help sustain share prices.
Remember
Most sectors tend to move in cycles.
Sectoral funds allow focused diversification. But understand a fund's objectives before investing.
For instance, a pharma fund could be investing in risky bio-tech companies.
Five alerts to detect bear market bottom:
1. Cash is king: At the bottom of a bear market, everyone agrees that cash is the best place for your money. Even fund managers hold stacks of cash. This money eventually enters the market, starting the next bull run.
2. Value is easy to find: PE ratios will be near historical lows. The average dividend yield will be high and share prices may be lower than book value. On 1 Jan 2003, the Sensex PE was 14.7, when the index was at 3,390.
3. Falling interest rates: Interest rates usually start falling at the end of a bear market. Lower interest rates eventually revive economic activity.
4. IPO drought: There are very few new issues (IPOs) at the bottom of the bear markets. Promoters prefer to wait for the market sentiment to revive before they go public in order to get a higher value for their companies.
5. Liquidity increases: Broad money supply tends to increase at the turn of the bear market. Money is the lifeblood of the economy. Increased supply tends to push up asset prices.


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