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Of Bear Markets and Defensive Strategies

 November 14, 2012 11:46 AM

A couple of questions came in on yesterday's blog post that I wanted to try to answer.

One reader asked the percentage that Monday's trade raised in cash. Another reader answered for me that just about all such trades tend to be a couple of percent or so which was the case with this one. One thing to remember is that bear markets start slowly over several months giving plenty of time to get out. We choose a breach of the 200 DMA as a starting point because it is simple to track and easy to explain to clients, oh and we have a reasonable basis to believe it is effective for our objective of trying to avoid the full brunt of large declines.

One reader asked about getting whipsawed by the 200 DMA. The answer here depends on your definition of whipsaw. For example if we sold one position with a low single digit weighting, as we did on Monday, and the market were to start a six week 20% rally to close out the year then the drag from the sale would be negligible. Obviously a more aggressive selling of stock as some do would meet more people's definition of whipsaw. I don't think whipsaw pertains in the case of a small trade but you may view it differently.

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Another question was on how we decide what to lighten up on and if there is anything we would buy. It is different every time. Often we are looking to remove volatility but this time removed a holding that had not been doing very well. In an instance where removing volatility is a focus then you would expect that we would reduce exposure to a sector that is typically more volatile than most of the others. For investors who just use broad asset class funds then it would make sense to consider taking defense from their small cap exposure--for investors who believe in defensive action based on whatever criteria they deem suitable.

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We would consider buying market neutral funds and inverse funds and did so during the last bear market.

I want to repeat something from above;

bear markets start slowly over several months giving plenty of time to get out

The best thing would be for you to look at charts from past bear markets and see for yourself how this has worked before. This is a normal market behavior which has repeated many times and so I believe in the idea going forward.

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