The S&P 500 officially entered a bear market on June 13. Although the average bear market lasts just over nine months, many analysts are predicting a prolonged downturn in stocks as the Federal Reserve continues to hike interest rates aggressively. This has some investors wondering how they can get rich in a bear market.
Earlier this year, Jeff Sommer of The New York Times wrote a column on how new investors can navigate market downturns. If you’re a subscriber, I recommend reading it. For those who can’t see behind the paywall, Sommer explains why now is a great time for those with long time horizons to buy stocks:
Prices are much better for buyers than they were at the beginning of the year because we are in a bear market, which means simply that the stock market over all has fallen at least 20 percent from its peak. While the past doesn’t guarantee anything about the future, the fact is that the American stock market has always recovered from declines over stretches of at least 20 years. If you can plan on buying and holding stocks for 20 years or more, by all means, buy now.
Below I focus on practical steps investors can take to get rich in a bear market. It’s important to note that neither Sommer nor I are talking about getting rich quick. Rather, the point is to develop sound strategies that will help you grow your wealth over the long term.
Before you start thinking about how to get rich in a bear market, you must recognize the rules of the game. For the past several decades, the Federal Reserve has generally adopted dovish monetary policies. When economic shocks occurred, the Fed effectively lowered the cost of borrowing, incentivizing risk-on enterprises.
Dovishness leads to an erosion of purchasing power for the U.S. dollar. Since the greenback will be worth less tomorrow, it’s better to spend the money today. Further, since the dollar features a guarantee that it will lose money, investors enjoy an incentive to do something — anything — with their funds.
However, to combat rising inflation, the Fed has pivoted to hawkishness, implying a deflationary profile. Here, the dollar will rise in value tomorrow so it’s better to save money. Moreover, the greenback features a guarantee that it will effectively return value to the cash holder. Thus, investors have an incentive not to invest, unless the opportunity is so compelling that it’s worth setting aside a guaranteed profit.
You must understand this basic framework before attempting to get rich in a bear market.
This might seem like an obvious step, but I’m talking about real research, not simply browsing the internet for material that already aligns with your perspective. You might be surprised to find out how little research people conduct these days.
Human behavior with regard to the equities sector has been consistent over time. Even with the advent of the internet, people still fall for the same traps, such as chasing meme stocks or cryptocurrencies higher.
Don’t believe me? Yale professor Robert J. Shiller noted that in the runup to the 1929 stock market crash, people gravitated toward the latest platform of mass communication: the radio. On it, hit songs like “I Faw Down an’ Go Boom!” poked fun at the excesses of retail investors’ activities: “I got a tip to buy some stocks, lost my shirt, lost my socks.
The minute that I buy some stocks, they faw down an’ go boom.” The lyrics demonstrate that no matter the timeframe, people tend to act predictably when it comes to money. If you want to get rich in a bear market, you must do your research rather than simply jumping on the latest fad.
Contrarianism can be a profitable ally if you’re looking to get rich in a bear market. Because human psychology tends to create similar dynamics at scale, recognizing a development and betting against it could yield significant market rewards.
In a 1997 paper, Shiller notes that people “often tend to show, in experimental settings, excessive confidence about their own judgments.” Therefore, if you peruse social media platforms and identify a fundamentally ludicrous trade that nevertheless attracts the bullish attention of the masses, you might have a contrarian opportunity on your hands.
Jim Taylor, Ph.D, mentioned a series of psychological influences on the stock market. For instance, Taylor discusses confirmation bias, or the “propensity to seek out or interpret information that will validate our beliefs. For example, if a trader really likes tech stocks, he or she is more likely to look for market information that will justify buying or retaining them and dismiss contradictory information.”
While it sounds cynical, you can bet against the empty hopes and wishes of the masses.
Under an investment framework, leverage refers to utilizing borrowed money to increase the potential return of a particular trade. When I talk about using leverage in the context of how to get rich in a bear market, I’m referring to the forward discount inherent in acquiring deflated shares of fundamentally sound companies.
Let’s say a sharp downturn materialized before you had a chance to buy put options or employ a similar strategy to make money from falling asset prices. You can still make money via the traditional buy-and-hold mechanism. To do so, you’ll want to identify the most resilient companies and load up on them.
Several years ago, McKinsey & Company published an article about the role of emotions in driving market behavior. In their analysis, the authors recognized that human emotions can influence the equities sector “in a few short-lived situations.” However, they ultimately concluded that fundamentals still rule.
Bear markets offer investors a chance to buy great stocks on the cheap.
The safest way to get rich in a bear market is to buy great stocks cheaply, not cheap stocks at an even cheaper price. In a game of probabilities, you want to give yourself the greatest odds of success. That said, when you have your bases covered, it might not hurt to consider some small-cap opportunities for your more speculative capital.
The attraction here comes down to the math. Typically, a market downturn will impact the lesser-capitalized companies first and to a greater extent. Therefore, you may be able to acquire a larger stake than would have been possible in a bull market.
Note that this strategy presents big risks. Smaller companies sell off first for a reason. They may not have the capital to withstand an economic downturn like their bigger peers. So, when considering more speculative stocks, focus on those with relatively solid financial metrics, such as a robust balance sheet or a positive trend in retained earnings.
It goes without saying, but I’ll say it anyway: If you want to get rich in a bear market, you’re going to need patience. And I’m not talking about a few months here. It’s possible that investors could face years of deflationary cycles.
Japan fought deflation for decades, trying every trick in the book to raise prices. Finally, it got some inflation, but it’s the wrong kind. I’m not forecasting a similar situation in the U.S., but I also wouldn’t be quick to assume we’ll be flipping from bear to bull market in the near future.
Looking at the historical data, between August 1929 and March 1933, the purchasing power of the U.S. dollar increased by 38%. When it hits, deflation can be a nasty and frustrating ride. No one hopes for this scenario to play out. However, it’s better to be prepared for it.
Though not a market-related idea, the concept of effort may be one of the most effective if you’re looking to get rich in a bear market. Many people resort to mediocrity as their baseline, just doing enough to get by. While that attitude may have cut it during a bullish market cycle, in a deflationary one, it could derail careers.
As myriad sources have pointed out, it’s better to go the extra mile. Those who do have a better chance of keeping their job during a recession. What’s more, it’s quite easy in this age of resistance to going back to the office to demonstrate your value simply by going back to the office.
As real estate billionaire Stephen Ross recently pointed out, in a recession, employers were less likely to lay down the law due to the tight labor market. “But I think as you go into a recession and people fear that they might not have a job, that will bring people back to the office,” Ross said. “You have to do what it takes to keep your job and to earn a living.”
Get ahead of the curve by showing your value now. After all, you’ll need to be making money in order to get rich in a bear market.
The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.