Dealing With The 2022 Bear Market

The past eight months have been one of the worst periods we have seen in the junior markets. It’s been the worst half year in the markets since 1970, and also been the biggest capital destruction ever in the markets with approximately US$25 trillion being wiped out of the equity markets and much more again in the crypto, commodities and bond markets.

It’s been very tough for all of us. In the face of this nasty bear market, some of our less experienced members have asked me to write a piece on some suggestions/advice on how to deal with bear markets.

These are just my own thoughts and point of view gleaned from having gone through many bear markets owning junior ASX stocks.

The Macro View

Firstly, let me say, I have no idea how long this bear market may continue. The world’s major economies are pretty stuffed right now. They all have way too much debt, and during Covid, rich-country governments created and pumped ridiculous amounts of new free money into the economic system. This free money party caused most asset markets, real estate, stocks, bonds and commodities, to become inflated in price. Also, less people worked, and supply chains broke down but demand for stuff and things increased, so guess what? Now most of the world is suffering the consequences of heavy inflation – all logical.

Left unchecked inflation will destroy any economy. So it has to be reined in. There are essentially two ways to reduce inflation.

1. Hike interest rates to slow the economy. However given the indebtedness of most advanced nations (the US for example is 400x geared to its GDP), increasing interest rates by too much will likely collapse the whole house of cards - the stock, bond, commodity, and property markets fall, as would most demand for goods and services and it will end in a recession. Recessions are traditionally bad for stock markets.
2. Governments to suck the money back out of the economy – which is what’s happening now in the US. The Fed said earlier this year that they wanted US$7 trillion taken out of the economy in the next six months. But guess what - by saying that - the ensuing sell-offs in the equity, bond, commodity and crypto markets have evaporated something like US$40 trillion. However, quite a bit of that money left the markets to shelter in cash USD, AUD etc and is now waiting for the worst of this storm to blow over and any indication the markets have bottomed. Eventually, this reduction in the value of assets has a wealth effect, which reduces people’s demand and ultimately rein in inflation – but again – this often causes a recession – which stuffs stock markets.

So the options available don’t look so good, but there is a middle-way, to let a bit of both happen until the money supply and debt are sufficiently reduced. Hopefully, the governments can manage that without causing too much of a recession, or engineer a soft landing. But honestly, who knows if it’ll work?

In the meantime, it does look like we are going to have higher inflation for a while. Inflation traditionally is not good for market performance in general, it lowers PE ratios and reduces profitability for many companies.

But inflation is usually good for commodity prices – most of our 10 bagger (and multibagger) calls are commodity-related stocks. But if we do go into a global recession that tends to make commodity prices fall, which will be bad for our stocks.

One way or another it will get fixed. But it may take much longer than we expect to play out. I have no idea how long, as there are too many conflicting theories and indicators.

But the stock market is a forward-looking indicator which has already discounted much of this macro stuff and some markets like Nasdaq, crypto, Hang Seng Index, etc. are already down 40%-60%, so much of the bad news above is already discounted in share prices.

Conversely, forward-looking markets also rise early, so when things look really bad that’s when the stock market will probably just start picking up again and all the cash waiting in the wings will begin to come back in and as normal, the markets will climb a wall of worry into a new bull market.

Stock markets usually do what the least people think they will. And as a majority of people now seem to be bearish they could now turn at any time. (As in who’s left to sell?)

However, often the end of a bear market is marked by some rather cataclysmic events like a war (we’ve got that already) or a major bank collapse (happening in China?) or a slew of bad earnings that caused a last “capitulation” round of selling.

As I said above, I have no idea when this bear market will turn. But it will. I personally suspect (for what it’s worth) that we shall drift sideways to down a bit more through the summer (Ozzie winter) and later in the year the markets should start to pick up again.

Some General Facts About Bear Markets

Based on the S&P index in the US researchers have calculated the following:

1. There have been 26 bear markets (when stocks have fallen by 20% or more) since 1928 and 27 bull markets. That’s a bear market every 3.6 years.
2. The average length of a bear market is 9.6 months. (We’re about nine months into this one.)
3. On average stocks have fallen 36% in a bear market and on average they have gained 114% in the ensuing bull market.

Whilst there have been 26 bear markets since 1929, there’s only been 15 recessions. So while most bear markets happen in a slowing economy they don’t always end with a recession.

Half of the S&P’s strongest percentage performance up days occurred during a bear market. 38% of the market’s best days ever took place within the first two months of a new bull market – usually, before it would be defined as a bull market (i.e. before stocks had recovered by 20% or more from their lows).

Therefore – from historical data at least – it seems the best way to weather a bear market is to stay invested where possible.

Bear market downturns are regularly occurring and are a temporary part of the process of ten bagging.

How To Handle This Bear Market

1. Make Sure You Are Comfortable With Your Cash Levels

Whether you have a job or just make your income from investing, as I do, the main point is to have enough cash to be comfortable with. If you do not then, sell some more shares - even though at a loss. Then your mind would be less stressed and you will be ready to buy more of your targeted stocks in case of any sudden dramatic falls.

Don’t fret that your investment is underwater, or you are taking a loss, or you think this may be the bottom. It may not be… Things can always fall much further. The main point is to have enough cash so you are comfortable for the next year or so, and then just be patient.

2. Understand The Companies You Have Invested In

The secret is work. Do your research, read the discussions on each stock on our Discord server, read the company announcements and understand the companies you are invested in. If you are uncomfortable, sell them. If you like them and have and have conviction – hold them. Then during these falls you can be comfortable buying more. The committee and most members do understand pretty well the risks and reward potential in our 10 bagger calls. That belief would make it much easier to weather through the bearish periods.

The stocks we choose are usually early-stage development stories. Whether in mining, tech, business or medical. Early-stage development stories are usually the ones that can 10 bag more easily. It is usually far easier and quicker to go from a $10m market cap to a $100m market cap - than it is to go from a $300m market cap to a $3b market cap.

But it is also much easier for early-stage start-ups to fail. The companies we choose need to have a promising asset, project or business thesis. They need to be undervalued compared to their peers or their future potential value. They need to have the ability to raise cash and most importantly they need good, proven and motivated management who also own a lot of shares in the company (preferably which they have paid for with cash).

Such promising companies with all those four assets mentioned above are hard to find. Which is why we started this ten bagger club. There are more than 2,000 companies listed on the ASX market alone, and 44,000 listed companies around the world.

Amongst our 1,000 or so members, there are at least 50-100 smart and experienced small cap investors. That gives us access to knowledge, connections and ability to find such good companies rather than just looking out by yourself.

The second we lay our eye on potentially perspective company, we do a lot of research and follow its progress pretty closely. We talk to the management regularly, we know if they are progressing more or less as expected, and we usually know pretty soon if the wheels are starting to come off a bit.

Small companies being efficiently developed into bigger ones is one of the fastest wealth-creation processes in the world. That’s what we invest in. And usually the main ingredient they need is time.

All the potential 10 bagger companies we have currently called do seem to be progressing well. So while this overall bear market has meant their share prices have been dropping, underneath they have funding and keep on working on developing their businesses. For most of the companies we invest in, the main thing we need is patience, they normally need time to develop their business or mine and for the share price to rise to reflect it. Bear markets are just some of the road bumps on the way.

3. When the Gains Come (As They Do), They Usually Far Outperform the Losses

From past experiences, we have found that well over 50% of our calls tend to work well (moving up between 100 - 1,000% or more.) In the end, even if less than half are winners – which makes us some hundreds or thousands of percent gains, while the others that fail or partially fail and don’t go anywhere or give us some tens of percent losses – we still end up winning a lot.

Losing 20-50% temporarily in a bear market is not comfortable while it happens, especially if it drags on for many months or a year or so, but in the end it’ll be well covered by the few that go right and you can find yourself with 1,000 to 3,000% gains.

Just a few such ten baggers can significantly impact your lifestyle and make you financially free. If it was easy, more people would do it. But we do get many calls right - and we will continue to.

When we started 10 baggers in the 2020 lows and the government was pumping cash into the economy and the markets were in that bullish environment we called 13 10 baggers in under two years. Now as you can see from the Morningstar chart (below), we are getting back to those same undervalued levels.

Number of Undervalued ASX Companies Soars

Since September 2021, the bear market has been sandpapering us to death with constant and continual falls. One could be easily demoralised by it. But we are keeping the faith because bull markets do follow bear markets, and as shown above by the starts from the S&P, the first runs north are where the biggest gains are made. And often the least expected. So it’s usually not good to sell all hoping to buy back in cheaper later, because sods law usually applies. If you sell, the next thing it goes up — just as if you don’t sell it goes further down!

4. Think Of Our Calls As Direct Investments If It Helps

In some ways, in some of the more illiquid companies we hold, it may help if you think of them more like direct or private equity investments. As in, forget the market’s daily share price auction. You have invested your money into a project and then you have to wait until it is the right time to sell, and just ignore the interim share price fluctuations. However, you can get liquidity if you really need it, and of course, if the price falls further (and you have some cash left) then you have the chance to buy it cheaper.

5. Think Of A Box Of Breakfast Cereal

Knowing the business of your company confidently can bring us to the example of a box of breakfast cereal. If you know and like the cereal and you are confident about what’s in the box of cereal that normally costs $2, and one day you see it on sale at $1. Logically you would be happy and try to buy more while it’s on sale, right? But that mentality often doesn’t apply in the markets – often people get worried why it’s on sale for $1, and doubt what’s in the box and maybe sell the boxes they already bought at $1 for $1 just in case.

Conversely, if the price of that box of cereal went to $4 in the shop, you probably wouldn’t buy it so expensive unless it was hard to get anywhere cheaper. But in the markets, if that box of cereal’s price moved up to $4, people are often more likely to go and buy it then than if it went back to $1. (Which is why price rises create volume in junior stocks - it’s not always the other way around as we are often told.)

Stocks are also like boxes of cereal - the more you market them the more people buy them. So, as we are often in small and relatively illiquid companies, and you want to help the share price in the company you are confident enough about to have invested your own money into - then tell the market about it! Tell your mates and others about it. Get on social media, Hot Copper, Twitter, etc. and tell the market about it.

If more people come to buy it, the share price may get stronger. It also creates more awareness about the stock and more volume in the stock. Having a stronger share price, more market awareness and more volumes would benefit any company – it allows for the company to raise new money to help develop the business - which ultimately justifies a higher share price and hence the marketing.

In Summary

1. No one knows if this bear market will continue for three months more, or three years more.
2. Make sure you are comfortable with your cash levels – in case things get worse.
3. Get to know your company’s business, understand their market and issues and then be confident in them (or not) as most of these companies mainly just need time to develop.
4. The markets do recover and stock prices of good junior companies do go back up. We just don’t know when.
5. Some companies may not make it, or the commodity price they are dealing in will fall to a level to make them uneconomic. But as long as several of our calls do work we end up winning a lot.
6. Be patient - but also be vigilant. If you don’t need the money, sleep easy, things usually always come good in the end. Yes, it’s frustrating being down, it’s frustrating waiting, yet suddenly next thing you know you’re up and we’re back in the next bull market.

I hope this helps some of you to be less worried.