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Robert Stephens, CFA
Robert Stephens, CFA
Articles (429) 

Charlie Munger on Preparing for the Next Bear Market

Planning for a slump could be a productive use of your time

November 10, 2020 | About:

Preparing for the next bear market does not seem to be a priority for most investors at the moment. Market sentiment is buoyant. This has contributed to the S&P 500's 58% rise since its March lows.

However, no bull market has lasted forever. They have always been followed by bear markets. Therefore, in my view, planning for the next market downturn could be an effective means of avoiding today's overvalued stocks and exploiting low valuations further down the line.

Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) vice chairman Charlie Munger (Trades, Portfolio) has a solid track record of capitalizing on bear markets to purchase undervalued securities. His ability to ignore other investors and willingness to wait for the right investing opportunities may have contributed to Berkshire's track record of market outperformance.

Ignoring the investment herd

It is tempting to adopt the same mentality as other investors during a bull market. For instance, many investors are currently optimistic about the growth potential for a range of companies. This is leading to increasingly upbeat earnings forecasts and rising valuations that may not factor in potential risks during a turbulent economic period.

In my opinion, thinking independently of the investment herd during a bull market may lead to a more efficient allocation of capital. It may allow you to make a more balanced judgment about the risks and rewards presented by an investment opportunity. This may be a more productive use of your time compared to spending a disproportionate amount of effort focusing on potential returns. It may allow you to avoid disappointing returns from today's overvalued stocks as the bull market eventually runs out of steam.

Munger has always sought to avoid copying other investors where possible. As he once said, "Mimicking the herd invites regression to the mean."

Waiting for the right investing opportunities

It can be difficult to wait for value investing opportunities to come along while a bull market is taking place. Even though the average bull market has previously lasted just three years, it can feel as though time is moving at a much slower pace while other investors are generating high returns. This may lead some investors to give up on waiting for undervalued opportunities. Instead, they may end up buying overvalued stocks to avoid missing out on further short-term stock market gains.

However, I think that using a patient approach can represent a productive use of your time. Cash savings may offer minimal returns at the moment. However, a bear market can present extremely attractive buying opportunities that adequately compensate you for the low returns generated while waiting for attractive stock prices to come along.

As Munger once said, "The big money is not in the buying and selling... but in the waiting."

Responding quickly to market movements

Preparing for the next bear market may provide you with an advantage over other investors. For instance, holding cash at the moment may mean that you are in a position to quickly respond to temporary mispricings during a market fall. Low stock prices may not be available for an extended period of time. This was the case in February and March this year, when the S&P 500 quickly recovered from its 33% decline.

Likewise, researching companies and sectors prior to a bear market's occurrence may help you to pinpoint where to allocate capital when the next market decline takes place. This may further improve your capacity to respond to short-term market movements while other investors are not in a position to purchase undervalued stocks.

As Munger once said, "Our game is to recognise a big idea when it comes along, when one doesn't come along very often. Opportunity comes to the prepared mind."

Disclosure: The author has no position in any stocks mentioned.

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