By Michael Cintolo, Chief Analyst, Cabot Growth Investor and Cabot Top Ten Trader
Don't read the above title and assume we're predicting some big, bad bear market. Even after this week's damage, the major trend of the market is more sideways than down, and it's certainly possible that the market snaps back yet again from this week's dip.
But the fact is that our trend-following indicators have been negative for a few weeks, while our Two-Second Indicator, which serves as an "early warning system" for market tops, has been mostly flashing red since the spring of last year. Combined with the horrid action to start 2016, it's certainly possible a bear phase could get underway.
We've been through countless downturns since Cabot started back in 1970, but it's been a few years since the last bear market. Thus, it's prudent to review the best way to survive a bear market … should one get underway.
First and foremost, remember the goal in a bear phase is to preserve capital. Why? Because making big money is extremely difficult! If you're aiming to buy stocks, almost every stock and sector will eventually get yanked down before the bear phase ends. And if you want to go short, there are two challenges-first, the math works against you (making 40% on a short sale is practically a home run), and second, your timing has to be precise (big declines generally happen in a few days, whereas advances occur over many months).
Thus, for the most part, we're content to stay mostly on the sideline during bear phases-in 2008, we averaged a cash position north of 60%, and were actually 90% in cash when Lehman went bust. It's not exciting, but it does preserve capital and, importantly, preserves your confidence. (We can't tell you how many investors threw in the towel late in 2008, and didn't return to the market for two or three years, missing the big gains that followed.)
However, we're not against doing something; indeed, even in general downtrends, we'll usually have 20% to 30% invested. We generally see two options, one on the long side and the other on the short side.
Starting with shorts, we do think having exposure via some short index funds can work; for instance, the ProShares Ultra Short S&P 500 Fund (NYSEARCA:SDS) moves up about 2% every time the S&P 500 drops 1%. Or, if you don't want to deal with leveraged funds, you can just do the one-for-one short fund (symbol SH), which simply moves the opposite of the S&P 500. (For the Nasdaq 100, the leveraged short fund is QID, while the one-to-one short fund is PSQ.) As we wrote above, you're not going to make big money doing this, but it can help make up for a few losses.
If you do short, though, it's usually best to do so after the market has rallied for a couple of weeks, and to not let your winners run. Thus, if you own a short fund, and the market keels over sharply for a few days (like it did last August), you should book at least some profits, as a snapback rally is likely.
On the long side, we obviously favor looking for resilient stocks. But it's also best if the stock and sector have already gone through the wringer, bottomed out for a while, and are showing signs of life due to a definite positive fundamental change.
The idea we have right now is solar stocks, which were cut in half as a group between March 2014 and last August, tested that bottom a few times during the following four months, and then launched higher after the solar tax credit was extended for another few years in December.
One stock we like very much is SolarEdge (NASDAQ:SEDG), a recently public company that's aiming to be the Intel of the solar industry. It's come up with a new solar solution that, due to its different architecture (it has power optimizers on each module that connect to its own inverter, instead of simply one big inverter), results in much greater performance and even lowers costs. SolarCity (NASDAQ:SCTY) and Vivent (the two largest residential solar installers) are customers, as are other big players.
Sales (up 72% last quarter) and earnings (up 414%) have been booming, and while growth should slow some this year, the tax credit renewal should keep orders pouring in for many quarters to come. Shares came public last year at 18, ran up to 43, but then fell all the way back to 16 during the sector's bloodbath.
But SEDG surged in December on its highest weekly volume ever on the tax credit news and, along with many of its peers, has held those gains. It's still early here-just 67 mutual funds own shares-but this is a situation that could make upside progress even if the market remains under pressure. SEDG is on our watch list.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.