We are going through a period of uncertainty in the market and several forces are at work. The technology hasn’t performed so well lately, with disappointing results from several companies, and major index engines like Meta Platforms (FB) are actually seeing their first signs of real maturity. Inflation is also a major concern, as it can decimate stocks and the economy, where rate hikes have become market prices, with Fed communications on this becoming quite clear. In general, M&A activity is also reaching feverish levels that likely indicate an upcoming peak, especially with restructuring activity being so unusually subdued, primarily due to a low rate environment that will soon change.

Overall, a correction or even a bear market could occur, especially when it comes to inflation news. Due to supply shortages and all kinds of logistical challenges as evidenced by tight supply chains, we believe that a higher rate will not be enough on the demand side to address all the supply side factors that affect inflation. Demand might decline, but demand for goods versus services, where supply chain issues are involved, might still be higher than pre-COVID due to profoundly changed spending habits. If the markets are not ready to digest this result, we could see a bear market. What can investors do in this scenario where inflation is the cause?

How can investors protect their money in a bear market?

We believe that stocks always provide an answer. Being such a broad and diverse asset class, there will always be a subset of stocks that can do well in almost any type of bear market, as long as you have an idea of ​​what the issues might be underneath. underlyings of this bear market. We will always park cash in stocks. When markets are less certain, we’ll just do it slower and more selectively. Selling positions to lock in gains where things get too bullish puts you in a position to slowly re-establish well-documented positions when markets may begin to decline, lowering new positions on average to position yourself for an eventual rebound, with bear markets almost never last more than eight months.

In order to protect your capital, in an inflation-linked bear market, we would consider commodities with very fixed cost structures as an option. Companies like Suzano (SUZ) tick those boxes. Fiber prices are not rising because forests are so abundant, even though lumber prices are rising due to bottlenecks at sawmills as seen last year. Meanwhile, the price of the pulp that SUZ sells has almost doubled. Alternatively, we would look at companies with strong balance sheets and quality businesses, still, ideally, with relatively fixed cost bases and trends that put them on the right side of their operating leverage. As an example, we would take Dassault Aviation (OTCPK: DUAVF). The demand for private jets that they currently have is mostly from the ultra-rich for recreational purposes. Rich end markets tend to be safe, and COVID-19 happens to be a tailwind for this type of use case. In addition, the defense segment is doing better than ever, with agreements signed with the United Arab Emirates and more recently Indonesia demonstrating that the 4.5th generation Rafale can still beat an F-35, which is supposed to be the most sophisticated fighter at 3 times the price, in bidding wars with even rich countries. Defense is still a fairly resilient segment thanks to the backlog, and Dassault has what every company should have in times of uncertainty, which is a margin of safety against a lower multiple. In fact, Dassault has almost a 0x multiple on its operating businesses, with non-operating assets accounting for the bulk of market capitalization. Indeed, any company with an EV/EBITDA multiple greater than 10x that we view with suspicion, and low multiple companies will generally have less of a chance of falling if things go wrong, as long as they have an economics that protects them from inflation.

Can you make money in a bear market?

The point of carefully selecting stocks when the thesis is robust to adverse outcomes is so that you have resistance and can establish a position as price, and if you are a Grahamesque investor, the risk of the business declines. The reason we do this is because you shouldn’t expect to make money in a bear market. Most traders fail to make money on volatility, so investors shouldn’t expect to either, at least in the short term. The purpose of a bear market is for you to establish positions that have been thrown out of portfolios in a panic with riskier stocks, in order to pay less for quality companies that are not so risky. Strong balance sheets are therefore a good start, and since inflation is the big concern these days, exposure to commodities can also be wise when a downturn won’t decimate the price of the commodities they are selling. Low multiples are always good too, as stocks with low multiples are unlikely to have reached the exuberant levels we might see in a leading market, and will have less room to fall sustainably. Once you’ve made wise purchases, you’re set to make money in the market rebound. That’s what we did during the initial outbreak of COVID-19, where we purchased Signature Aviation, an FBO private jet, where we made immense returns just because “Aviation” at the end of the name meant that it was completely ignored by the markets for months, although its markets were not commercial aviation at all, but private aviation which recovered very quickly with clear reasons.

Conclusion

Investors should consider selling their bullish positions and positioning themselves against the backdrop of more persistent inflation, which we expect over the next 2-3 years due to supply constraints driving inflation, not Requirement. Raw materials are attractive, but only where input costs are likely to stay low. Steel could be difficult due to its energy intensity, as well as raw materials like aluminum. Suzano’s paste does not present this risk and the paste is used in many hygiene products, as well as in packaging, used extensively in e-commerce and infrastructure construction. Continue to consider low stock multiples as they are less likely to have been swept away by the markets. Foreign stocks may not have seen the same gains as US stocks due to the retail boom and general market excitement in the US, where people are much more invested in stocks. than in almost any other country in the world. Moreover, strong balance sheets will resist rate hikes both in connection with Fed decisions, but also due to persistent inflation that may occur on the supply side, regardless of the decision. from the Fed. Dassault is net cash, for example, and benefits from operating leverage with resilient markets. The multiple there is also exceptionally low. Finally, buying habits should be slow and sensible. Take the time to fully understand the next company you are investing in and focus on protecting it against inflation and the economic downturn that may result. When you understand a business watchlist, don’t waste all your money at once. Move in when it reaches the levels you want, and be disciplined and judicious. If a bear market is on the way, it will likely happen within a year as more rate hikes and more inflation data come out. You may be slow to reinject your money, and you should have funds to reduce the average.