It’s Time to Start Preparing for the Upcoming Bear Market
While 50% of the country is unhappy with the outcome of the election, I think we can all agree we’re glad that it’s over. Not only do we no longer have to suffer through a barrage of campaign ads, we can finally start planning for the future without the uncertainty of an election looming over us.
The presidential cycle is a four-year pattern in the stock market that many analysts have identified. There are variations of the pattern with some analysts starting the cycle in January when the new president assumes office, while others believe it starts in November with the election. Either way, though, the general consensus is that the first two years of a president’s term are the most difficult for the market.
Once in office, a new president must make a variety of tough decisions. There are almost always problems the previous president was unable to resolve, and there are new problems that develop. In the first two years, presidents seem more willing to take decisive action, likely because there is a better chance voters will forget about any wrong moves by the time the next election rolls around. In the past, this has led to below-average stock market returns in the first two years of a new president’s term.
We can speculate on policy, but no one knows what will happen in the first 100 days. President-elect Donald Trump may face a rough start to his term with a recession and bear market possible — but that was likely going to be the case no matter who won.
Even before the election, The Wall Street Journal’s monthly survey of economists said there was a 60% chance of the next economic downturn happening within the next four years.
One reason to expect a recession is simply the age of the current expansion. For now, the economy continues its slow recovery from a deep recession that started in December 2007 and ended in June 2009. The Wall Street Journal noted that the current expansion “has now continued for 88 months, making it the fourth-longest period of growth in records stretching to 1854.” Since the end of World War II, there has been a recession about every 70 months, on average.
The current expansion is long in the tooth, and no matter who’s in the Oval Office, no president can restart the clock.
Bear markets often accompany recessions, so we shouldn’t be surprised if we see a bear market at some point in the next four years. Knowing that the first two years of a president’s term are historically the weakest for the stock market, it’s reasonable to expect this long-running bull market to struggle in the near future.
How I Plan to Profit From Fear in the Market
I actually find the prospect of a falling market much less scary than most investors. That’s because it’s times like these when readers of my premium advisory service, Income Trader, and I pocket bigger income checks.
When traders become spooked and bearish headlines dominate the news, this translates into a surge in the Volatility S&P 500 (VIX) index.
The VIX measures the implied volatility of S&P 500 index options. When investors become scared, volatility typically goes up, which means that investors are willing to pay more to hedge their downside risk or protect gains. And I’m willing to take their money to buy their stock… but on my own terms.
I set the price I’m willing to pay for their stock, and in return, they pay me cash up front. I do this by selling put options.
Think of it like this: Imagine if home and auto insurance premiums fluctuated with the weather. If the weather is good, then insurance is cheap. But if there’s a hurricane looming, then premiums skyrocket.
Now, you could take the chance that a hurricane won’t hit and choose not pay the sky-high premiums. Or you could hedge your bets and pay higher premiums to protect your personal belongings.
The VIX is the market’s way of measuring investor fear of potential devastation. It indicates whether investors are willing to pay more to protect their investments.
When I sell puts, I’m acting as the insurance company, but I’m very selective with which stocks I will “insure.” The best insurance companies are masters of pricing in risk — the good ones always make sure they come out on top. Along those lines, I won’t pick stocks that are likely to be swept up in a metaphorical hurricane. Instead, I focus on the companies least likely to be affected so I can simply pocket the premium and move on.
Just like a good insurance company, you have to have good underwriting skills to know which stocks to “insure.” And, so far, my “underwriting” skills have been spot on. Since February 2013, I’ve closed 140 trades and 134 have been winners.
For example, I recently told my Income Trader readers about a company that generates $117 billion in revenue and was trading 13% below its fair value price — in other words, a company that I’m willing to “insure.”
In return, my readers and I will instantly pocket anywhere from $30 to $300 with a click of a button in our brokerage accounts.
My readers and I are “insuring” a new stock each week. If you’re interested in getting my “underwriting” tips and learning more about selling puts, I’ve put together a simple eight-minute tutorial you can access here.