Where to hide – a factor approach

Not about calling the downturn

This post will be about, how to best position your portfolio for a bear market. I just want to begin by saying, I’m not calling the market peak. As we know markets can stray irrational longer than you can stay solvent, at least if you are betting against it. I believe markets to be somewhat irrational right now, with little to no regard to risks, which is shown forexample in the record low market volatility. But with this portfolio I’m not in the game of betting against it (going short). I want to earn the long-term equity risk premium (a.k.a. Beta). Looking at stocks on absolute basis in a more normalize world (meaning healthy equity risk premiums, normal interest rate and inflation levels), I really struggle to find stocks that feels cheap, have a margin of safety etc. More and more I tend to see sell side analysis (and fellow bloggers) value companies on a peer basis, “this is cheap relative to this”. And when something actually is valued with a DCF, when you replicate their analysis, you find that they have used ridiculously low equity risk premia or WACC for the discounting. If you shift that discount rate up by only 1-2% and all of a sudden the stock goes from a buy to a screaming sell. I don’t like it, but as I said, I’m not going to try and time when we get a major pullback.

What do to?

So I believe we are in for a bear market with a -30% fall in stock markets from current levels in the coming years. But I (obviously) don’t know when it will come. This belief means that we will see a multiple contraction, or lower earnings/margins, or both. Let’s play with the thought that markets keep being valued  (same multiples) as today and companies earn the same. For every year that the markets do not fall there is an equity risk premium (albeit lower) and dividends to be harvested. Which means staying outside the market waiting for the crash has a expected cost. The expected cost is more or less the current discount rate the market has on earnings (a.k.a. the equity risk premium). It’s good to have this in mind when playing with the thought of protecting oneself from a market downturn.

So what do to and where to hide?


Well the easiest answer is keeping some cash, and that is what I haven done. Since I started my portfolio, I have kept a high level of cash and only been fully invested for a short period. Holding this cash has been a way of for me to stay ready for the downturn. I want to hold some cash for that time when you can pick up companies on the cheap. This has been a stupid strategy so far. The GlobalStockPicking portfolio is up 40% since inception and I held and average cash buffer of 9.8% for that period, that is a performance drag of 4% (cash earns 0% in my model portfolio). Even if we see that pullback in markets I’m talking about (-30%), I will need to time it pretty darn well to come out positive, compared to always being fully invested. Meaning I would need to deploy all cash almost at the bottom to gain back what I missed out of.

Cash Levels in GSP Portfolio


As can also be seen in the graph above, during 2016 I did not consistently hold high cash levels, It was more an affect of my wanting to sell an holding and not having something new lined up. Whereas this year, 2017, I have with some variation, held cash at around 14%. It aligns fairly well with my feeling for the market, 2016 I was still fairly bullish (although still very worried). Now I’m turning fairly bearish and especially US markets feels insanely valued, especially considering that interest rates have moved up. I have probably been skeptical way too early, but I’m not about to change now. But the conclusion must be that this is been a quite poor strategy, which has been masked by me managing to pick stocks that have outperformed. Outside the world of this blog on a personal level I have kept even more cash on the sidelines, which has been terrible (so far).

Categorizing holdings

I would argue that I can categorize all my holdings into one of these 4 factors (although sometimes they might fit into more than one category):

  • Growth
  • Dividend
  • Quality
  • Value

A quant would use a stricter definition in terms of different ratios to define what stock falls into which factor. I will from the knowledge I have about my companies, in a more “soft” approach classify my holdings.  These four categories have different general characteristics in terms being high/low Beta and also resilient in different macro economic environments. For example high/low inflation coupled with high/low interest rate levels. By looking at holdings in this way, we can get a better feel for how they will be repriced in a bear market and/or higher interest rate environment. The below picture is one guide to how different factors perform in different environments.


As you see there is other ways to categorize a portfolio than my 4 factors, for example if the company is a small or large cap (Size). This can be very important in a bear market, because what might seem fairly liquid in a bull market, can be very hard to trade in a bear market. And when liquidity dries up in a stock, that stock should all other things equal trade down, due to a increased illiquidity discount. But I will start by grouping the portfolio into the four categories above.

1. Growth – Highest risk

When the bear market already is a fact, growth stocks have in many cases already collapsed. The reasons for it is fairly simple. Growth stocks valuation is built on the expectation of continuous growth of revenue and earnings. And when markets fall significantly, that is usually the end to (high) growth for most companies. A more scientific way of putting it would be that a growth company has it’s cash-flows further in the future (the duration is higher than for a highly cash generative, non growing company). When markets fall the equity risk premium goes up, meaning that discounting those cash flows far away in the future will suffer more. The same duration argument is true when rates are rising, where the risk free rate is a component in the equity risk premium.

Whichever way you look at it, growth companies have high Betas and will drag down your portfolio more than the benchmark when markets fall. Of course if you manage to find the company that still grows while markets in general fall, you will be better off, stock picking still applies and that is your alpha. But in general with higher equity risk premia even your alpha generating picks will not yield you as much as in a bear market. The idea then surely would be to rotate out of these kind of stocks if one believes in a coming bear market. So somewhat surprising I have a large portion of my portfolio is in this category.

My holdings I consider Growth:


My largest holding, thanks to the tremendous gains (and favorable currency development). Mainly a Norwegian online bank, challenging the “old” banking model. The stock has traded up in the general strong trend of bank stocks, but has also with it’s superior growth been able to outperform. This has been something as unusual as a growth company which has not traded at so stretched multiples. One big worry right now is the Norwegian property markets which has shown its first signs of weakness. The real test will probably be this autumn when larger volumes will be moving to see if this a new trend. Long-term I believe in their case of challenging the big banks, but there will be serious trouble if the property market really dives.


I actually bought this knowing that we are late cycle with construction booming in the Nordic region, historically Ramirent then always does very well. The market usually reprices the stock fairly rapidly when the late cycle earnings start to kick in. This is something I’m looking at off-loading as soon as I find something new interesting to invest in.


The main company in China to benefit from larger EV usage. They are currently profitable, but most of it’s value is in the expectation on future earnings.


Sportswear and wild-life retailer with good track-record of profitable growth. Can they keep it up? I believe so, but if I’m wrong this company will for sure trade down.

2. High Dividend Stocks – defensive?

With zero interest rates high dividend and companies with large buybacks have both been popular strategies. Companies which such characteristics have in general seen great multiple expansion. And rightly so, such a stock can be seen as a perpetual bond. And with long term bond-yields decreasing, that should transfer into the equity world that all else equal, these stocks should trade higher. I have tried to hold some high dividend stocks in my portfolio, especially when I started my portfolio I held the SAS Preference share which had a yearly dividend yield around 10%. There is also an important difference between high dividend, high risk companies, and very stable non-cyclical companies paying decent dividends. Many dividend stocks should be defensive (low beta) in a market downturn. But high yield and leveraged companies where the market is crowded in search for high yields, could be a real minefield. My SAS Pref shares was of the later type and that was one big reason why I sold out when I thought the market started to reach the end of the bull market. I have tried to find dividend stocks that are less cyclical and can keep their pay-out levels even when the cycle has turned.

What I’m trying to say is that dividend stocks can be off all types, some defensive, some rather high leveraged companies in a market with falling revenues (oil/shipping/coal etc). If interest rates would go massively higher, the world will probably in general be vary shaken up. But of course a stable company with limited growth opportunities, yielding perhaps 4-5% will look much less attractive if the risk free interest on your bank account also is 4-5%. These kind of stocks could go from darlings to very uninteresting in such a scenario.

My holdings I consider high dividend:


My recent investment in ISS, I saw as a fairly high dividend case. Not because of current dividend yield, but due to my expectation on them raising the dividend. I also saw this holding as a way to make my portfolio more defensive. They have paid of their debt and are highly cash generative, which I hope means that they will raise the dividend yield up towards 4.5%. The cleaning and service business probably will be somewhat affected if markets fall, but I would not call it cyclical, their contracts will be fairly stable. But of course stable businesses with high dividend yields is a bit like looking for the holy grail, you will struggle to find it. I do not think ISS is the holy grail, but a decent option to make my portfolio more defensive through fairly high dividend payments.


Another case where the dividend currently has plummeted, due to the complicated convertible bond structure. But with revenue increases from the newly build Naga2 casino expansion, I expect this to again be a stock paying healthy dividends in the 5-6% range. Another positive has been the latest development around this convertible bond, where the majority owner has agreed to somewhat more reasonable terms from conversion and therefor the stock has bounced significantly from it’s lows. It’s still a cheap stock, due to its dented reputation and the way the majority shareholder has treated the minority in the past.


With the recent lowered guidance for growth and turbulence of the leaving CEO I got the opportunity to buy this company on the cheap, it has come up a bit now from it’s bottom, but still trading cheap. Even if the market environment seems to continue to be tough, I expect them to keep delivering a 5-6% dividend yield.

3. Quality is surely the most defensive?

Real quality companies maybe is the way to go then, for a defensive portfolio. Better than holding cash and safer than high dividend companies? Well.. ..in theory yes, but the problem is that defensive quality businesses are naturally more very expensive stocks. The question becomes how much are you willing to pay for this quality? Low interest rates and people scarred by the 08 crash have in my opinion created some crowding into these stocks, which means that they are many times trading at very stretched multiples.

Let’s look at a few examples of prime quality companies. I picked out some of my favorites (from a company perspective) out of Goldmans Sustain 50 list: Goldman Sustain 50

Some metrics Quality companies


And to put the figures into perspective, let’s compare it to my current portfolio

Same metrics for GlobalStockPicking Portfolio


Looking at the table above, I think there is plenty of room for multiple contraction for high quality companies. As well all know the FANG club and some other have been darling stocks for many many investors lately. This also happened in the 70’s when the large American companies were trading at very stretched multiples (Nifty Fifty). Let’s take a well known example, Coca Cola, what says that P/E 24 is a reasonable level for this company? Well with low interest rates maybe that is where it should trade.  Let’s take a look from a long term perspective.

Coca Cola P/E the last 30 years


What this graph tells me is that, the market can get even more ahead of itself and value Coca Cola on P/E 30, giving it another 30% upside (+ future dividends currently at 3%). That is something of the blue sky scenario for a holder of Coca Cola shares. A blue sky scenario with 30% upside does not sound great to me. I rather see this one trading down to P/E 17 in a weaker stock market, but that of course still might be defensive and a smaller drop compared to the benchmark, still making this a defensive play. But again a defensive play with very little upside does not make sense to me (if the yield is too low). Then I rather keep cash, or rather, there must be better options out there. But of course fairly valued quality companies would be a very interesting candidate to invest in and perhaps I should allocate larger portfolio weights to the ones I found.

My holdings I consider Quality:


Given that this company is even on Goldman’s list I don’t think further explanation is needed why I classify this as Quality. What I will say though is that obviously I have been way to quick to scale down this holding, since this type of company just keeps defying gravity. But at this valuation levels I’m not far from throwing out his holding, a company can be wonderful, but not at any kind of valuation levels.


Amazing company, delivering high quality gaming experiences to the Chinese, and the best part, the valuation is not too stretched. The reason for that in my opinion is that you are running other risks, in terms of concentration risk against the Chinese market and that the company needs to continue to deliver new hit games indefinitely to justify its valuation.


Delivering food packaging products world-wide with a strong track-record of execution and partnering with world leading companies to deliver coffee cups and much else when coffee companies expand worldwide. As long as management keep delivering as in the past I don’t see anything stopping this company to keep growing at a moderate pace for many years to come. A boring but high quality business.


A company standing on many legs, everything from movie production, TVs, to PlayStation. I think they have a strong product portfolio and I really like the video-games. VR has not become as big as I thought, but still has a lot of potential. Current P/E levels is pretty crazy at 79 (a mistake in my table above).

4. How about Value then?

We do not want to pay too much (high multiples) for our investments, we then end up in some type of value stocks definition. But in this market finding true value cases is not easy. In my opinion you either end up buying micro/small cap stocks in markets where the companies have been forgotten. You then run a large risk of a value trap, and illiquid holdings. Meaning yes you are right, the company is trading at a (unfairly) low multiple, but it could keep doing so, for years and years. It’s going to be a very frustrating investment. You are right on the numbers, but the market keep you in the wrong on the valuation.

If you instead move over to larger companies, you instead end up with cases where there is some serious market disruption or company specific crisis. Some of these cases turn around and you have a great investment on your hands, but it’s a serious wager against consensus. And although it’s good being contrarian one should be humble enough to accept that the market very often is right. Right now you could probably make a Value case for stocks like Kohl’s and Macy’s in the US. In the Nordic market perhaps Ericsson that I discussed and owned before as well as Pandora, the danish jewelry maker. All of them with their own set of problems.

I love to find good Value cases, but it is getting increasingly difficult, and mostly I end up finding them in the Chinese market.

My holdings I consider Value:


After scanning the market for the best way to play the Electric Vehicle market, I chose this stock together with BYD and LG Chem, this has been the largest disappointment so far. It seems that a small company as Coslight with already high debt levels has a hard time scaling up in the way needed. I still haven’t given up on the company though. Recently they announced a partial buy-out of one of their main battery factories to be able to scale up and lessen the debt burden. It shows that there are investors out there that believes this company is sitting on a lot of value. They made a sizable profit last year and are trading at around trailing P/E 9.

LG Chem

This is reasonable priced Chemicals company, why I put it in the Value bucket, is the hidden value from the battery production business. This I believe will be unlocked and re-rate the stock over the coming 5 years.


A Belt and Road play with fairly low multiples. This a holding I have got more unsure of as markets totally ignore the Belt and Road progress so far. Not sure if it was a good idea to invest in a company mostly owned by the Chinese government.

XTEP International

The company in my portfolio with the lowest valuation, but also of the type described above. Small cap and ignored by the market, classical value trap. And a very similar case like Zhengtong Auto which I owned before and sold after holding it for a long time to a loss. Unfortunately for me, the company is today trading 200% higher than my selling price. The value in that one was finally unlocked, but I didn’t have the patience to hold on to it. Will this be another case with a similar story, or just a company that never will deliver?


Stock picking is about alpha, and it should be possible to generate alpha both in bull and bear markets. But a lot of free out-performance can be gained in a bear market thanks to having the right type of factor tilts in your portfolio. My portfolio is fairly diversified in the different factors, but I could definitely have more Quality in my portfolio. I find it easier to find reasonably valued growth company cases right now, it naturally becomes easier to see companies as cheap when you put a high growth figure in your forecast. But as I said, that might be an unreasonably positive expectation if the cycle turns. I would like to have more Quality and Value in my portfolio, but I struggle to find good investment ideas. If you have some favorite stock picks which are defensive in nature, please share in the comments.

Another problem of being a stock picker is that you tend to hold much more small caps. Naturally it’s in the less researched stocks that you can find mis-pricing, this will also hurt the portfolio in a bear market. Buying small caps is not something I’m willing to stop with, because I believe it will be too hard (impossible?) to generate alpha otherwise. This is just an unfortunate problem you have to live with as a stock picker.

Holding cash has not been a successful strategy so far, it would have been much better to be fully invested. I put myself somewhat in a corner keeping this cash buffer, since I really believe we are in a very late stage bull market. So for the time being I will continue this strategy, although it is not in general a good idea trying to time the market top.

7 thoughts on “Where to hide – a factor approach

  1. Very interesting reflections.
    I also wonder how the markets are still surfing the many waves the globalized economy is continuously providing. Europe’s landscape I see it this way:
    – lots of money were artificially created & fed to the system to prevent its implosion
    – inflation remained extremely low, leading to very low public interest rates
    – a big portion of created money remains trapped in systemic positions (some of which solved ‘private’ problems), sustaining valuations (else bankruptcies would explode) and not contributing to inflation.
    – workers productivity increased significantly, above their wages. Increased productivity means basic necessities still are affordable.
    – withdrawing QE money from the system would trigger the chaos it has been preventing. Hence, the game will go on until a weakest link point is reached (whichever cause: Trumponomics, China imploding, Spain’s bankruptcy after “CatalEXIT”, another tech-bubble, north-europe immo collapse, oil/gas market issues).

    In such scenario, my market exposure is 75% only, awaiting for opportunities any now&then, and considering non-China emerging markets small-caps (via ETFs).

    2.Oct I will review my outlooks.

  2. OHI is a healthcare REIT with a healthy dividend. Healthcare REITs are typically a defensive sector that still chug along during economic downturns because people will still service the old. With healthy demographics from an aging population, this is an interesting trade

    1. Could be interesting, but I don’t know how much debt are these REITs sitting on, I guess that could increase the risk a lot?

      I have been looking at companies that owns Hospitals lately, but they are very expensive..

  3. Great post. It is a difficult dilemma. I do think we need to see have some kind of catalyst (event) to start things of. I do not yet see this, but there are a lot of potential catalysts. What do you think about Novo Nordisk, a Danish company. It’s one of my biggest holdings right now. I think it’s decently (under)valued. I think it’s a defensive company but also a dividend play. I’m starting to accrue more cash, but I’m not selling my stocks yet. I’m also writing puts a lot on good companies at much lower prices, they generate some cash..

    1. I have owned Novo in the past. I think it’s a quality company were the valuation run way ahead of itself due to the long strong performance streak they have had. Now the stock has normalized and I feel it is fairly valued (in the sence that the market has a more balanced view of the company, I haven’t made a deep valuation of it myself), an OK investment but not really attractive enough for me at this point.

  4. Thanks for some sensible thoughts in this post.
    I find the topic “Belt and Road” very interesting, and would like to encourage you to elaborate on this subject whenever you feel like it.

    Whats your take on various commodities at this point? Not everything have been in a running bull market for the last decade..

    And since you asked, I’m currently having a look at CF Industries Holdings, Inc. (CF). Which might be something to look at (haven’t decided myself yet) as a more defensive play? Don’t seem to highly valued, appears to have ok BS/Cash flow, dividend around 4%, overall they are one of the lower-cost producers. Stock have struggled a lot the last few years due to falling fertilizer prices. I guess a rebound in fertilizer prices are needed to really make it pop but they seem to be in a position where they can wait out the bad times so to speak.

    1. JoeyDowie Thanks. The Belt and Road I’m sure will be a long lasting big theme, but very hard to know how to play it, it’s too political, so I think I will give it up for now.

      Regarding commodities, I don’t have strong views of future pricing, one of the few commodities I have studied for a quite long time is Uranium. It’s been picked up by quite a few how long it’s been running in a bear market. I think with the weapons-scrambling going on right now, they might cut short supplying the market from the stock pile they have from their decommissioned weapons grade plutonium. That could totally upset the supply/demand. I don’t want to commit too much money to it, but I have been looking at perhaps re-entering Uranium stocks with a small position.

      Fertilizers is another of those areas, just as Uranium..

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