- Eric Hoffer
“We do not free ourselves from something by avoiding it, but only by living through it.”
- Cesare Pavese
“When you’re afraid, you run. When you are afraid of a bear market, you run by selling. But much like with a bear, running rarely saves you. You have to stand fast, take the measure of your decisions, and decide to buy, sell, or hold. A good investor gets excited in bear markets, not fearful.”
- Thomas Gates
2022 hasn’t been easy on investors. Through September 27th, the S&P 500 has lost 23.1%. Over the past thirty days, the index has lost 8.5% alone. There hasn’t been any place to hide. Domestic stocks, bonds, international stocks, you name it. All there is to see is an ocean of red. In a recent interview, I was asked what I thought was an astute question. The interviewer asked me, “what do you think is the most important thing as an investor in a bear market?” She also asked, “what do you think is not important in a bear market?” I thought I’d take the time to briefly sketch out an answer to those questions.
I frequently quote Shelby Davis: "You make most of your money in a bear market; you just don't realize it at the time.” We sure hope that’s true since we technically tipped into a bear market this week. We agree completely with Mr. Davis. It is nearly impossible to beat the markets without one of three things: buying low and selling high, buying high and having the stock go much higher, and/or reducing costs to a minimum. A combination of the first and last are the attributes of many great value investors. To achieve the first - buying low and selling high - bear markets are a great place to start. So, let’s begin there ourselves.
Important Things for a Bear Market
When bear markets settle in, the fear of losses can shake up the best of us. Many individuals sometimes find themselves frozen and unable to make any decision. Others sell quickly, regardless of any well-thought-out investment process or valuations. The great investors I’ve known have a few immediate reactions, which are very different from most. First, they aren’t scared by bear markets but rather excited by them. They see a marketplace filled with bargains as far as the eye can see (remember: buy low and sell high!). Second, along with this excitement comes a certain Zen-based calm where they can apply their investment process and utilize data to make decisions, not their emotions. Last, they tend to shut down any media that might be available – no CNBC, no Bloomberg, no Jim Cramer. They might not watch a lot to begin with, but now they watch none. They focus their attention on what can help them - data such as annual reports, financials, market research, etc.
I think this is 90% of the battle in making money in bear markets, but not all of it. The factors I discuss next are just as important for investors in any market. But during a bear market, they play an outsized role in reducing risk and creating long-term value for shareholders. If an investor can get their emotions in check and then keep an eye on the following few things I discuss, I think they have a better shot than most at making a bear market work for them.
“Must-Have” rather than “Like-to-Have.”
It’s incredible how quickly a company can ascertain the strength of its customer needs for its product/services during a bear market. Nothing shows the depth of a portfolio holding’s moat depth than when faced with the sudden loss of easy money. Anybody who has run a business can tell you how quickly buying decisions can change when the markets and the economy head south. When this happens, you want a portfolio company deeply embedded in its customers' strategy and operations. Many of Nintai’s portfolio holdings have mission-critical products and services for their clients, ranging from Manhattan Associates (MANH) supply chain solutions to iRadimed’s (IRMD) MRI-compliant IV pumps.
Deep Financial Strength
While this is always a requirement for any holding Nintai Investment portfolios, it’s essential in bear markets. Frequently, economic disruption is part of bear markets, including such things as recessions and disruption of the credit markets. Because of this, it is critical that a portfolio holding has both the strength on its balance sheet (no debt, significant cash) and cash flow statement (high free cash flow margins) to survive any downturn. You never notice the lack of cash until you don’t have it, which usually comes at the worst time. Thirteen of twenty stocks in the Nintai Investments portfolios have no short or long-term debt, and nineteen of twenty have free cash flow margins greater than 25%. Examples include Gentex (GNTX) and Abiomed (ABMD).
High Return on Capital
An investor should keep an eye on - whether the stock markets are in a bull or bear market –that their portfolio company generates a high return on invested capital. Much like the investor who has dry powder in a bear market, companies can accelerate their value generation when the markets are at their lowest ebb if they wisely put capital to work. That means finding acquisitions at dirt cheap prices or simply buying back its stock when shares are trading at a significant discount to their intrinsic value. Great companies can set themselves up for long-term success by judicious use of capital allocation in bear markets. The average return on invested capital in the Nintai Investments portfolios is 41%, significantly greater than the S&P 500’s 10.2%. Examples include Expeditors International (EXPD) and SEI Investments (SEIC)
Things to Not Worry About
As important as keeping your eyes on the things that matter, it is equally important to ignore things that cause your mind to get muddled in its thinking. This can be difficult. During bear markets, all kinds of things can rush through your head, with the flight or fight response being the most powerful. It’s easy to grasp any tidbit of news or advice as something that might stop the pain. Here are a few things that can quickly lead you astray from your investment process.
There is no end to the predictions you can hear about the markets, whether in a bull or bear. What’s most challenging with these predictions in a bear market is that your mind is most susceptible to accepting some terrible advice. Statements like “in the past 60 years, during the autumn period, when there is a shortage of energy products, combined with predictions for a strong Christmas season and warmer weather, 75% of the time, markets have gone up from here” sound like they are well reasoned, but meaningless to any value investor. Sometimes market predictions are simpler like “the market has nowhere to go but up from here.” Actually, the market has two places it can go – higher or lower - so that one isn’t even close to being true. In a bear market, turn off the media, but down the iPad, and focus on things you can control. Trust me. Wall Street market predictions aren’t one of them.
Timing the Market Bottom
This one is the kissing cousin of “Market Predictions.” If I had a nickel for every person who has told me they invested in a particular stock right at the bottom of the market, I’d have……. lots of nickels. In the hundreds of years of the United States markets, the reality is nobody has been successful at making a career of timing the markets. The last thing an investor should worry about is correctly calling the exact time and place of the low. As the saying goes, it is better to be approximately correct than precisely wrong. Investors can always dollar-cost-average further down and make slightly less on their investment.
Finding New Opportunities
This might sound counterintuitive, but if the companies you own in your portfolio had the suitable characteristics to purchase and that remains the same even in the bear market, an investor should look to load up on additional shares. Though it may seem exciting to find fifty other companies that look like potential investments, the place to start is the companies you already own. If you liked them at bull market prices, you should love them at bear market prices. A caveat: sometimes we get things wrong when building an investment case and a company we have chosen sees its business case deteriorate in a bear market. In these cases, an investor would be wise to dump that holding and perhaps look for something new. But, in general, look to add to existing positions before casting about for new opportunities.
In any bear market, there are two things an investor must focus on to be successful. The first is getting their emotions under control. If that can be achieved, it can drastically reduce the unforced errors that happen so frequently during a bear market. The second is to focus on the things that matter (and what you can control) and ignore the things that don’t matter. It helps to have an investment process in place before the bear market sets in so that you help data and process drive your decision-making process. A successful investor is usually pretty good at shutting out the stuff that doesn’t matter – the talking (or screaming in some cases) heads, the market experts with a 22% accuracy rate, or sometimes simply the noise that goes along with fear on Wall Street. While we're not perfect here at Nintai, we think bear markets are a good opportunity to reevaluate our investment cases, dollar-cost-average on existing positions with compelling discounts to intrinsic value, and if there are no current opportunities, look for new investment opportunities outside the portfolio. We wish you luck as we enter this new investment phase.
I look forward to your thoughts and comments.
DISCLOSURES: Nintai currently owns shares of Manhattan Associates (MANH), iRadimed (IRMD), Gentex (GNTX), Abiomed (ABMD), Expeditors International (EXPD), and SEI Investments (SEIC) in client portfolios, the Nintai Investments corporate portfolio, as well as my personal and family portfolios.
 The one exception I am aware of is the infamous “Haynes Bottom,” when Mark Haynes, the former host of CNBC’s Squawk Box, called a market low on the exact day (March 9, 2009). You can see it here: (https://www.youtube.com/watch?v=S-81qgyRQzA) I concede I was a massive fan of Mark.