Cash is king in bear markets

Reading time: 6-9 minutes (1.679 words)

Most of the time you get the advice to invest your money because staying in cash costs you money due to inflation. While that is true the majority of the time, sometimes you want to have cash ready to invest. Especially when things are looking red in a bear market. Where most investors panic when they see red numbers, the people who actually know what they are doing are looking for buy opportunities. This makes more sense looking at this from another point of view:

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Let’s assume you did your due diligence and bought stock X for $10, wouldn’t you buy more when the same stock hits $5? Maybe hoping it will drop even more?

Because it does not make any sense if you were willing to buy stock X for $10 and start to panic when the price is down 50%. The reason why most investors panic is because they did not do any due diligence and just bought some random stocks or crypto and are following other investors who are panic selling. Meanwhile thinking they need to get out because it may drop even further!

That is no way to trade or invest because the only thing that is driving your decisions are emotions. When all prices are going down (bear market) that does not mean the fundamentals of a company changed. Unless something specifically bad happend to that market. For example airliners vs covid. Bear markets are most of the time caused by global events, not because companies suddenly forgot how to do business. Bear markets will filter out companies that made bad financial decisions first. For example:

Energy companies (providing electricity and gas to homes) can buy energy and gas on the “market”. They can buy in low and sell at a higher rate to customers. Most of the time it’s possible as a civilian (or company) to settle a contract for multiple years. This way you pay a fixed amount for electricity and gas for the next one, three or five years. You won’t always know upfront what the best decision is simply because you can’t know what will happen in the future.

Some of these companies buy and sell electricity and gas on the spot. Meaning they settled a contract with a customer but continue to buy and sell on a daily basis instead of buying the total amount of electricity and gas needed till the end of the contract. Normally this will not cause much problems. But in the last two years (2021/2022) energy prices spiked like crazy. Suddenly, these providers were not able to fulfil their contract against bargain prices. If they just bought in all energy and gas to meet the demands of the contract there would be no problem. Many smaller energy providers went bankrupt due to this simple reason.

  • Customer settles a contract for five years and needs to pay $0,2 for each kwh and $0.7 for each m3 gas (based on 1500 kwh and 1200 m3 gas a year)
  • Energy provider continues buying and selling electricity and gas contracts on the market at current rates
  • Suddenly the market changes. Prices of electricity and gas on the global market spikes to $0,35 per kwh and $3 per m3 of gas
  • The energy provider has to buy in each kwh for $0,35 while the customer only pays $0.2

Or

  • Customer settles a contract for five years and needs to pay $0,2 for each kwh and $0.7 for each m3 gas (based on 1500 kwh and 1200 m3 gas a year)
  • Energy provider buys in 1500 kwh and 1200 m3 * 5 years right away
  • When suddenly the market changes, there is no problem to fulfil the contract requirements.

When you are investing in a bear market, you want to have cash ready to invest. Because at some point, people will panic. When the panic starts, you can make money. For example:

FTSE All-World UCITS ETF (VWRL) source google.com

When you look at the beginning of 2020, prices were reaching all time highs. When covid-19 hit the news, price plummeted from almost €90 to €60 in a few days time. If you have some cash ready, you made some nice profits here if you bought in all the way down using the buy the dip strategy

If you were already invested or did not have any cash you would have missed an easy way of huge returns. Only two years after the dip to €60 price reached €110, almost a 100% return on your investment. Keep in mind these are unrealized returns. Profits are only real if you actually sell.

But who would have predicted that covid would ruin the stock market at the beginning of 2020? In this case it was hard to predict but right now (june 2022) is a whole other story. 

Cash is also king when inflation is high

Inflation decreases the value of money. When inflation rises that would mean you should not hold cash. At least that is the general consensus. And if you look at it in a logical way it makes sense. But the monetary system has many wheels and high inflation will always cause other things to happen.

First you should bear in mind that inflation is always personal. Overall high inflation does not mean you face the same decrease in value. There are a few reasons for that. First of all, inflation is based on key components in the market but not all. It’s just an average. Meanwhile, one part of the market might be overreacting because of an overall high inflation rate. For example, when energy prices surge this will have a larger impact on inflation rates. But if you have an energy contract you settled a few years ago and with an end date of 2025 you won’t see that much impact. Another example are gasoline prices. They represent a big part when calculating inflation rates but what if you take the bicycle to work every day? Although overall prices might rise, not everything affects every individual.

In order to stop inflation from rising too quickly, central banks will adjust interest rates sooner or later. Higher interest rates means getting loans costs more money. While companies were able to get loans with practically zero interest rates, they were able to use this money and extend their business. 

People could lend more money to buy houses or other things. This also stops when interest rates are going up. Housing prices will also go down eventually if nobody can lend the amount of money they need. Overall, people have less money to spend when inflation is high. That means companies earn less money. As a result, stock prices drop. And that means you can have a look for buying opportunities. If this is combined with other negative things going on in the world this can cause a panic reaction. Covid is still here and the war in Ukraine vs Russia is still going on strong. The media is already talking about bear markets and recessions. 

For investors, this is very good news because this will pull markets down and might cause a panic. And that is where your cash comes into play. If you have a large sum of cash during times of panic, that is where you will see the most profits. And although inflation is high, stocks decrease even more in value when the panicking starts. Just look at Amazon:

Their shares dropped from $2400 to $100 the last few days. Keep in mind that they issued a 20:1 stock split in June 2022. So the price dropped from $240 to $100, more than 50%. While inflation is reaching 10%, that is no way near a 50% drop in share value.

Predictions 2022 and beyond

The last few months (2022) started pretty well but news is dripping in about high inflation and increasing interest rates. Before covid was here (pre 2020), central banks injected a staggering amount of money in the economy (2+ trillion in the U.S.). Many companies barely survived the corona crisis and more money was needed. Most companies still have to pay back government loans or other loans related to covid-19. Bigger companies start to fire people instead of hiring new people.

Inflation reached almost 10% in the U.S. which is the highest rate in a few decades. Meanwhile the overall interest rate was near zero. This has never happened before in the history of the stock market. Many financial gurus like Warren Buffet and Robert Kiyosaki warned about crashes and other uncertainties in the market. Current stock prices are falling and the crypto market is noting heavy losses. A great moment to get ready and buy!

Keep in mind that the stock market has been surging since 2008. Even during the covid pandemic we saw a huge drop but an almost unreal recovery reaching all time highs while covid was and still has a huge impact on our lives. And Covid is still here. What will happen next winter?

The war in Ukraine vs Russia is also causing a very disrupting market. Although some might say that markets are manipulated and are kept artificially high to make extra profits. Currently there is no real prediction when the war will end. It might last for several more months or even years. Ukraine is one of the main commodity suppliers in Europe. 

The only way to fight high inflation is by increasing interest rates. And that is exactly what the central banks did. All markets are in the red right now (june 2022) and will probably go down further as the central banks will increase interest rates in the upcoming months / years. 

There is no reason to panic at this moment but it would be a really good time to go over your investments and do some rebalancing. Maybe even get out of positions in its entirety. If prices continue to drop, you’ll be able to buy them back at a discount. Always do your own analysis. 

Key Concepts:

  • Having cash in a bear market is not a bad thing. Even if inflation is high
  • Cash allows you to buy in more when the market panics
  • But in long bull markets, staying in cash will cost you money

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