While some continue dancing, the music might have already stopped: are we already in a bear market in stocks? In this context, we study past bear markets to see whether gold may serve as a valuable diversifier for what's ahead.
Are we in a bear market?
A “bear market” is frequently defined as a decline of at least 20% in the S&P 500 index. Trouble is that by the time pundits provide their seal of approval that we are indeed in a bear market, the index has already lost 20% from its peak. Many of them will likely have told investors to buy the dips all the way down.
In our August 4 Merk Insight Coming Out – As a Bear!, we argued that a bear market is about to commence. Mind you, that was just before the surge in volatility. At the time, some wondered why a “currency and precious metals” guy like myself would have anything to say pertaining to the stock market; just about a week later, there were numerous media reports blaming the currency markets for turmoil in the stock market. Go figure.
We are not going to repeat the entire bear case again, except to summarize that we believe we have shifted from an environment where investors think the glass is half full to one where the glass may be half empty. This is largely induced by the Fed's attempt to extricate itself from its 0% interest rate policy; that's because, in our analysis, just as the Fed's extraordinary policies have fostered complacency, any attempt to move away from it may cause fear to return to the markets. There are numerous implications, but one of them being that investors may be shifting from buying the dips to selling the rallies as their focus shifts from chasing returns to capital preservation.
How to prepare for a bear market?
In some ways, whether or not we are in a bear market already is not the most important question. Instead, investors may want to ask themselves whether they are sufficiently diversified to be ready for the next bear market, which will eventually come.
In the past, we have extensively discussed ways to diversify in an environment where many assets have been rising in tandem. We believe the tide has turned, and prices across a broad spectrum of asset classes may be at risk. We have discussed alternative strategies such as long/short strategies in the currency or equity space that each come with their own set of opportunities and risks. Today, we zoom in on gold. This discussion is not meant as an endorsement of any one tool to be used in a bear market. Instead we look at it in the context of the toolbox former Fed Chair Bernanke used to talked about: just as the Fed has had its toolbox, investors may to have one of their own to be ready for what may lie ahead.
