It's Hard to Make Money as a Bear
The better approach: Survive as a bear, profit as a bull.
John Rekenthaler
Mar 24, 2020
Mentioned: Berkshire Hathaway Inc (BRK.B)
Editor's note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.
Down Time
For the first time, I am an investment bear. I heartily dislike that status. I don't understand how to make money as a bear. It is far more difficult than profiting as a bull.
To back up: I do not believe that stocks have reached bottom. (This is my view, not Morningstar's.) After all, they have only recently begun to decline. Over the past century, no bear market exceeding 30% has ever ended after a single month. Sure, this downturn could be the first, but that is not how I would bet.
One problem is that willing sellers still exist. With stocks down so sharply, bargain seekers have entered the fray. Temporarily, they can support equity prices, sparking brief surges. Unhappily, such rallies are quickly squashed by those who close out their positions on uptick. The market will be better positioned to move forward when such investors are gone; but that process requires some time.
The other, more fundamental concern is that this bear market is like no other. To be sure, that statement is a cliche. No two bears are truly identical. This time, though, really is different. For example, Goldman Sachs forecasts that United States GDP will shrink by 24% in second-quarter 2020. If you think that sounds like a rather large amount, you would be correct. Since the Federal Reserve Bank of St. Louis' database started in 1947, the worst previous quarterly slump (in 1958) was by 10%.
Stock-market recoveries typically begin when investors believe that they have foreseen the worst. It lies ahead of them and therefore must be endured, but at least their worries are bounded. It does not seem to me that this downturn has yet reached that phase.
The Tax Man
The first concern for a newborn bear is taxes. Because stocks rise more often than they fall, bear-market investing tends to be tactical, thereby (if successful) generating short-term capital gains. In addition, some bear strategies require selling long positions, which, even after the recent stock plunge, are likely to be above their cost bases if the investor has held those securities for several years.
Any trades that incur taxes must be accurate indeed! For example, consider my position in Berkshire Hathaway (BRK.B), which closed on Friday at $170. (Note: I drafted this column over the weekend, as my curmudgeonly editors dislike last-moment filings.) Its purchase price was $70, and it resides in a taxable account, so selling that security realizes a 20% tax bill: $20 owed to the IRS on a $100 profit. Nobody is smart enough to succeed while regularly paying a 20% spread. No columnist at least.
True, when I eventually reinvest those proceeds, my new holding will have a higher cost basis, so one can argue that I have merely sent the IRS now what I must send to the IRS later. That claim fails. For one, time is money. The dollars I give the federal government today are not available for me to invest today. For another, my Berkshire position will never generate a tax liability, if I bequeath it.
In short (so to speak), bear-market investing is best done in a tax-sheltered account. When investing in a taxable account, it is much easier to dodge the IRS as a bull than as a bear.