Prepare for a bull market when prices are still falling during a bear market. Because bear markets are invariably followed by bull markets, it is important to raise cash and keep a handy wish list of stocks with target prices to buy, before a bull market begins. Bull markets tend to begin abruptly when things appear gloomiest, prices are in free fall, with no light at the end of the tunnel. When fear, pessimism, and pain reach their maximum, a bottom is reached, and a bull market begins. Here are things you can do to prepare for the birth of a bull market:
Save as much as you can. Cut down your discretionary spending, and raise as much cash as possible.
Sell bonds and other fixed income investments, so you can take advantage of the high returns of stocks in a bull market.
Sell gold when the Dow/gold ratio is well below the historic average of around 20:1.
Have plenty of cash deposited into a stock brokerage account, so you are ready to buy stocks once the bear market ends and a bull market begins.
Watch for a bull market to begin in the depth of a recession, when everything is still in free fall, and the economic outlook appears the darkest. If you wait till a recession is officially over, you would most likely miss a great portion of the bull market's gains.
Early in a bull market, when prices have just started to bounce back from the bottom, buy all kinds of stocks, but preferentially load up on the ones that have fallen the most during the bear market, typically the lower quality, cyclical stocks (such as Alcoa and Dow Chemicals). Lower quality stocks tend to have higher debt and lower margins and cyclical stocks are dependent on the business cycle, so they tend to be hardest hit in a recession, and will bounce back dramatically when the recession ends. Load up in stocks that belong to the hardest hit industries and sectors during the bear market, for example, the financial sector in 2008 and 1991. Likewise, focus on the hardest hit investment styles. If small cap stocks have fallen more than large cap stocks, buy small caps. If international stocks have fallen more than domestic stocks, buy international stocks. If value stocks have fallen more than growth stocks, buy value stocks. During the early phase of a bull market, only a few forward looking investors will believe things will get better and are willing to take new positions. As the outlook turns just a little less depressing, the market will start to move up from the bargain hunting.
Keep buying stocks and hold onto your positions as the bull market continues to rise, transitioning from early to mid phase. During the mid phase of a bull market, the economic outlook remains poor, but it will gradually seem less poor. Investors will begin to realise that improvement is taking place, and they will bid stocks up to their fair values. Fear of "double dip" will continue to keep prices in check from time to time, and a sizable minority will remain skeptical of the rally. The mid phase is usually the longest phase of a bull market and can last for many years. As long as skepticism in the market's recovery remains, the bull market will continue to rise, so be sure to hold on tight onto your positions.
As the bull market continues to rise during the mid phase, shift your focus more on high quality stocks and begin to pare down or sell the lower quality stocks to make room for higher quality ones. As the bull market matures, risk increases along with asset prices, and the hardest hit stocks tend to recover a lot more than higher quality ones (often lower quality stocks will go up by 300-400% when higher quality stocks go up by only 50-100%). As stocks prices go up, risk increases, so you should dial down risk by emphasising more on more on quality.
Know that when everyone finally concludes things will get better forever, the bull market has now transitioned from mid to late phase. At this point, euphoria sets in, and essentially all remaining bears turns bullish. As everyone is cheered by the improvement in the economic and corporate results, they will become willing to extrapolate it. Expressions like "new era", "new paradigm", "permanently high plateau", and "end of the business cycle" will be rampant. Paradoxically, future P/E may be low, based on overly optimistic projections for the next 12-month earnings. (Trailing P/E and P/E calculated based on averaged earnings over past 3, 5 or 10 years are always high, usually above 20, toward the late phase of the bull market.) Regret and greed become powerful forces, as the masses become jealous of the profits made by investors who were early, and they want in.
When everyone wants to buy, sell. Sell all the lower quality and cyclical stocks, if you have not already. Hold onto the highest quality defensive stocks if you are a long term investor.
Raise cash and get ready for the end of the bull market, to buy again during the next bear market. Hold off buying when the overall stock market has become irrationally exuberant, and remember that the next bear market is just around the corner.