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The Bear Market Ahead

Keeping your emotions at bay in a bear market is paramount.

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This too shall pass...

As I wrote in a recent GrowthInvestor blog post, I'm pessimistic about the potential for equity returns this year. A consumer-led recession will have a substantial effect on corporate profits, and the depressive atmosphere of a bear market will weigh on the multiples that investors are willing to pay for those profits. I want to prepare you, at least psychologically, for what is coming in the short term, but it's also important to remember that this too shall pass. The economy will take its lumps as misallocated capital is destroyed, but then the creative forces of capitalism will again be ready to take hold. It's hard not to be a long-term optimist.

Bear markets are painful and emotionally grinding, but they also present us with exceptional investment opportunities. There is an old saying that you make all your money in bear markets, you just don't know it until later. The key, however, is to keep your emotions from forcing you into bad decisions. Today, I want to talk about the emotions that suffuse a bear market, and how I believe GrowthInvestor's Growth Portfolio will be affected by a recession. If you can understand what is coming, you will be able to make decisions with your head, rather than succumb to that sinking feeling in your stomach.

An Emotional Meat Grinder
I've spent the last 10 minutes pecking at my keyboard trying to come up with a less macabre way to describe a bear market, but I can't seem to better the visceral accuracy of "emotional meat grinder." This chart, widely posted on the Web, is popular because I think it accurately captures investor emotions in both boom and bust cycles. The cascade of emotions from anxiety to denial to fear to desperation to panic to capitulation to despondency, and then finally to depression is gut-wrenching to say the least. As if that were not enough, the market may stage several rallies that bring temporary emotional relief, only to pound investors into the ground once again.

In this environment, keeping your head firmly in control of your investment decisions is extremely difficult, but exceptionally important. The only thing that matters, in any market, is the intrinsic value of our holdings. Selling your shares for less than they are worth because fear or panic grips you would be a mistake. On the flip side, you should recognize when other investors have given in to emotions and are selling shares for substantially less than they are worth. In that case, you should happily take the other side of that trade. We have a lot of cash in GrowthInvestor's Growth Portfolio, and I'm looking forward to some great bargains.

Growth Portfolio Holdings
The companies in the Growth Portfolio will have to endure a recession, though some stocks may hold up better than others. I've "bucketized" all of our holdings and here are my thoughts on some of them.

In this first bucket, I have firms that should hold up relatively well in a bear market for various company-specific reasons--companies including  MannKind (MNKD) and  Cheniere Energy (LNG). The ultimate value of MannKind, for example, doesn't depend on manufacturing output or interest rates, but rather on whether Technosphere insulin is approved by the FDA and is able to successfully find a place in multibillion dollar insulin market. The value of Cheniere is backstopped by take-or-pay contracts with major oil companies. 

In the second bucket, I'm putting growth holdings such as  MSC Industrial Direct (MSM). Companies in this category are broadly exposed to an economic slowdown. These stocks will likely have a difficult time in the short run and in some cases intrinsic values will be impaired. For example, Morningstar analyst Matt Warren recently reduced his fair value estimate for MSC to $53 from $60 per share to account for a recessionary environment over the next few quarters. However, MSC and many other stocks in this bucket are rated 5 stars, and I'm content to hold on to them.

That's my quick take on some of my holdings. Please bear in mind these short-term factors will not affect my decisions to buy or sell stocks in the Growth Portfolio. I really am focused on the long-term value of these businesses. My goal is simply to prepare you for what might lie ahead during the next few quarters. Saying one is a long-term investor is easy; putting it into practice, especially in a bear market, is hard. I want to make it as easy for you as possible to be a true long-term investor.

Click here to learn more about GrowthInvestor and the Growth Portfolio holdings.

 

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Toan Tran does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.