How to buy stocks on the edge of a bear market

Looks like everyone is in the mood for Friday shopping, except for Elon Musk. The Dow Jones Industrial Average breaking a six-day losing streak, Nasdaq Composite moved into the second consecutive active session and S&P 500 rallied more than 2%, a small step back from the brink of a bear market, ending the week down 16.50% from a 52-week high. The stock buying can continue, but any short-term or one-day stock price gains in this market are slim. The Dow fell for a seventh straight week for the first time since 2001.

Nicholas Colas, co-founder of DataTrek Research, said: “We saw the same thing in 2000 and 2001. “You know asset prices are falling, but the act of trading always gives you enough hope. … I’ve had a lot of flashbacks to 2000 over the past three months. …If you haven’t seen it, it’s been very hard to go through, and you don’t forget.”

For many investors who have flooded into stocks since the pandemic as the bull market once again seems to have only one direction, this could be the first time they have danced with the bears in a long time. For Colas, who previously worked at Steve Cohen’s hedge fund SAC Capital earlier in his career, there are a few lessons he’s learned from those years that “saved a lot of pain.” heart.”

Umbrella-holders walk past bulls and bears outside the Frankfurt stock exchange during heavy rain in Frankfurt, Germany.

Kai Pfaffenbach | Reuters

To begin with, the prevailing philosophy at the trading firm is to never short sell a new high and never buy a new low. As investors who have only been through a bull market are now learning, momentum is a strong force in both directions. This is not to say that investors should remove any particular stock from their sights, but a stock’s stability won’t be measured over a trading day or two. Investors should watch for signs of stability in the stock for one to three months. One exception: a stock that rallied on bad news could be one where the market is signaling that all the bad news is already priced in.

But for now, Colas said, betting big on a stock as a buying opportunity isn’t the best way forward. “Rule number one is to lose as little as possible,” he said. “That’s the goal, because it’s not like you’re going to kill it, and invest to lose as little as possible… when it’s our turn, you want as much money as possible.”

Here are some guidelines he has at the top of his stock buy list right now and how they relate to the current market environment.

Importance of VIX at 36

Volatility is a defining feature of the stock market right now, and the clearest signal investors can look for when selling dries up is VIX volatility index. VIX at 36 is two standard deviations from its mean since 1990. “It’s a significant difference,” Colas said. “When the VIX hit 36, we were selling well and really oversold, we had a strong panic mode,” he said. But the VIX has yet to reach that level in its most recent sale.

In fact, the stock market has only experienced one VIX close more than 36 times this year. That was on March 7 and that is a possible entry point for traders as the stock eventually rallied 11% – before the situation deteriorated again. “Even if you buy that close, you need to be nimble,” says Colas. VIX is saying that the inventory washout isn’t over yet. “We were dancing among the raindrops of the storm,” he said.

Short-term rallies often reflect shorter pullbacks rather than a clear signal. “Short pullbacks in a bear market are vicious and easier to trade than short,” he said.

Looking at some of the recent action in pandemic “meme stocks” like GameStop and AMC, as well as pandemic-winning consumers like Carvana and Colas say buying those rallies “is a hard way to make a living.” tough, tough way to trade,” but back in 2002, traders looked to the names that were in the big shortage, the stocks that sold the most for income.

Whether Apple, Tesla or any other, stocks won’t love you back

For investors who have made a fortune in the recent bull market, taking Apple or Tesla higher, this is the time to be “extremely selective,” Colas said, and even for stocks you don’t want to be. favorites, remember that they won’t love you back.

Here’s another way to remind investors of the most important rule for investing in times of volatility: dismiss emotions. “Trade in the market you have, not the market you want,” he said.

Many investors learned that lesson the hard way through Apple, down more than 6% in the past week alone. From the beginning of the year until now, Apple sank into its own bear market before recovering on Friday.

“Apple has a job to do in this market, and it’s not working,” Colas said.

Everyone from famous investors to Warren Buffett considers Apple “a great place to be,” and seeing it collapse as quickly as it did shows that the stock market is the equivalent of The safest haven trade is over. “We went from low risk to high risk, and it doesn’t matter if Apple is a great company or not,” Colas said. “Liquidity isn’t high and there’s a flight to safety for any asset class you can name… the financial assets that people are looking for are the safest ones out there. and Apple is still a great company, but it’s a stock.”

And with valuations in the high-tech sector as it used to be, it’s not a shame to dive in.

“You can buy it for $140 [$147 after Friday] and it still has a $2.3 trillion market cap. It is still more valuable than the entire energy industry. That’s hard,” Colas said. Technology still has some pretty crazy valuations. “

S&P 500 industries better positioned to recover

On a sector basis, Colas is looking more to energy, because “it’s still working,” he said, and for growth occupations, healthcare is a good “safe trade.” even if that comes with a caveat. Based on its relative valuation and weighting in the S&P 500, “It’s a good place to get a rally and not lose much,” he said.

History says that in times like these, healthcare stocks will get bigger bids as growth investors who don’t like the technology need to move into another sector, and over the years, The options they have available have shrunk. Not too long ago, for example, there were “growth” retail names that investors would look to amid volatility, but the rise of online retail has killed that commerce.

Colas emphasized that there isn’t any evidence yet that growth investors are diving into anything. “We haven’t seen a single sector in healthcare yet, but when growth investors’ attention returns, there’s not much else left,” he said.

What does Cathie Wood buy blue-chip mean

Even if Apple invests in selling, Colas said there is always a case for buying blue-chip stocks in a bear market. Cars, for which Colas have been on Wall Street for a decade, is an example of blue-chip thinking for long-term investors.

First lesson from Ford in this market, however, could be dumping Rivian shares the first chance it has.

“Ford does one thing well, and that persists, and right now it’s shuttered,” Colas said. “Press the sell button and get some liquidity. They see what’s coming and they want to be prepared to continue investing in the EV and ICE businesses.”

Whatever happens to RivianFord and GM will likely last for a while and in fact, guess who just bought GM for the first time: Cathie Wood of Ark Invest.

This doesn’t mean Wood necessarily ditched her favorite stock, top holding Tesla, but it does suggest a portfolio manager might admit that not all all stocks recovered on a similar timeline. ARK, has an investment fund Ark Innovationdeclines as much as the Nasdaq peaked and trough from 2000 to 2002, there is some basis for offsetting.

“I have no opinion on whether Cathie is a good or a bad stock picker, but it’s smart for her to look at a GM, not because it’s a great stock…. I’m not going to touch on that. it’s here, but regardless, we know it’ll be around for another 10 years beyond some cataclysmic bankruptcy,” Colas said. “I don’t know if Teladoc or Square will,” he added of some of Wood’s top stock picks.

One big difference between many people in the market and Wood right now is her belief that the years of disruptive themes she bets heavily on still apply and will eventually be proven. that right. But buying a blue-chip like GM could help prolong that disruptive vision. In a sense, GM was a second order to buy stock “without having to bet farms on unprofitable farms,” ​​Colas said.

Even in a market that doesn’t love any stocks, there are names that can be trusted. After the Nasdaq bottomed in 2002, Amazon, Microsoft, and Apple became one of the great trades of 2002-2021.

A bear market doesn’t end in a “V,” but rather an exhaustion flat line that can last for a long time, and stocks that end up doing aren’t all active at the same time. GM could benefit from Tesla even if Tesla hits $1.5 trillion in the next three years. “It’s the value of a portfolio at different stages, and there’s going to be things you get wrong,” says Colas.

GM’s purchase could be a signal that Wood will make more deals to diversify the duration of her fund, but investors will need to see where she will take her portfolio in the future. Next few months. And if it remains a confident bet on the companies that mess up the most, “I like the MPs,” Colas said. “We don’t know what will be in the ARK, but we know what will be the MPs,” he said. “I’d rather own the QQQs,” Colas said, referring to Nasdaq 100 ETF.

Even that has to come with a caveat now. “I don’t know if the big tech companies will ever go back to the way they were, because the valuations are so much higher,” Colas said. Microsoft is worth more than a few sectors with the S&P 500 (real estate and utilities), and Amazon is worth more than two Walmarts, “but you don’t have to bet on Teladoc and Square,” he said.

“We know they’re good companies and who knows where the stock will go, but the fundamentals are sound and if you have to trust you’ve picked Apple and Amazon next, it’s a deal. difficult translation,” he added.

Wall Street will fall even more

There are plenty of reasons in the macroeconomic lens to remain skeptical of any recovery, from the Federal Reserve’s ability to manage inflation to growth prospects in Europe and China, all Both have such a wide range of outcomes that markets must incorporate the possibility of a larger-than-normal global recession. But one key market data point that this has yet to incorporate is earnings estimates for the S&P 500. “They’re too high, way too high,” Colas said.

The fact that futures price-to-earnings ratios are not getting cheaper is telling investors that the market still has a lot of work to do in bringing the numbers down. Currently, Wall Street is forecasting 10% sequential growth in earnings from the S&P 500, which, according to Colas, is unlikely in this environment. “Not with 7%-9% inflation and 1%-2% GDP growth. The streets are wrong, the numbers are wrong, and they have to go down.”

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