3 Ways to Play the Next Bear Market

Nobody wants to think about it, but bull markets don’t last forever.

It’s the natural ebb and flow of investing, and as long as you are prepared, you can ride out a downturn or correction in style. Then, when it is over, you will be ready – and able – to take advantage of sale prices on great companies.

Now, we are not looking for a meltdown like we saw in 2008. The economy is in a much different place, and safeguards, especially in the financial system, are now in place.

However, there are signs that it might be time to think about playing a little more defensively.

How can that be? After all, the economic numbers look pretty good. And the S&P 500 just reached an all-time high.

You see, most of the “advice” you get from the media comes from people with a vested interest in having you buying more stocks.

The more you buy, the more fees and commissions they collect. That’s why it is usually too late when they finally back off their permanently bullish views.

Don’t get us wrong; we still think there are plenty of reasons to own stocks for the long term. Still, Money Morning Chief Investment Strategist Keith Fitz-Gerald sees a few changes occurring beneath the surface that could pose some short-term problems in the stock market.

“Strategically speaking, I think the rally could go on for another decade, which is why you want to invest accordingly,” Keith said. “Tactically, though, I sense a change in direction.”

Basically, that means it is time to take a few steps to cut back on your risk exposure and move some money into areas that can weather the short-term storm.

What’s Changed in the Market

Keith found several specific changes that lead him to his short-term defensive views, but one in particular stands out. The performance of cyclical stocks, which are very sensitive to the health of the economy, has not kept pace with the major indexes since May.

As we know, the Wall Street looks forward and reacts to conditions it sees several months down the road. For the cyclical stocks to be this skittish, we have to believe there will be a bump in the economic road before the year is over.

JPMorgan Chase & Co. (NYSE: JPM) analysts pointed out something similar. They looked at the performance of the S&P 500 consumer discretionary sector over the past 12 months and compared it to the performance of the S&P 500 consumer staples sector. The difference was eye-opening.

Over that span, the discretionary sector returned roughly half of what the staples sector did. This is important because the discretionary sector usually leads in strong markets, and the staples sector usually leads in weaker markets. So, while the S&P 500 itself soared to new highs, the usual leadership is upside down.

That’s a warning sign.

This divergence between current conditions and “normal” conditions must eventually resolve itself. The good way would be for the discretionary sector, which contains stocks of companies that sell things people want, such as TVs and vacations, to get its act together and rally.

Or the market can fall back to fulfil the prophesy of the stronger staples sector.

Which will it be? Nobody knows. That’s why we want to show you three ideas that will keep you in the game but keep your money safe at the same time.

Three Strategies to Prepare for a Market Correction

Keith recommends following a plan to protect against big losses should the market fall sharply, but that won’t require you to become a market timer and sell everything.

The first idea is simply adjusting your stops on stocks you already own. This is an often-overlooked plan, but it is important to have emotion-free, mechanical stops in place at all times. A stop, or stop loss order, is simply an open order on a stock to sell it should its market price fall to a certain level. This way, you will never take a devastating loss but will still give the stock a little wiggle room to recover from the normal day-to-day ups and downs in the market.

The next is to put a little bit of money into investments that actually go up in value when the stock market falls. Fitz-Gerald likes either the Rydex Inverse S&P 500 Strategy Fund (MUTF: RYURX) or put options on the major indexes for the summer. Considering that the market is at new highs and volatility is still low, these are still relatively inexpensive.

Think of them as an insurance policy. But you’ll want to keep a close eye on an inverse fund and be prepared to sell as soon as the market changes course.

Finally, prepare for the end of the market decline. That means get a list of quality stocks that you would love to own at lower prices. In fact, figure out what price would make your mouth water, perhaps 10% below current prices.

Remember, if and when the market takes it on the chin, some stocks will suffer only modest losses, but others will get clobbered. Why not put in orders to buy great stocks at ridiculously low levels?

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Source: Money Morning