What to do when a Bear Market is Coming

“I’ve made more money during recessions being long treasuries than short equities”

I’m pretty sure this is a recent Druckenmiller quote although I can’t find the interview where it’s from.

In any case the guy is right.

Surprising as it may sound it’s been a far superior bet to go long treasuries rather than short equities during the largest equity drawdowns of the past 30 years.

Here’s a couple risk adjusted return charts over the five largest S&P 500 drawdowns since 1993; comparing the performance of intermediate-term treasuries to the S&P 500 (SPY). These are measured from the Equity peak through the absolute trough. In other words, this would be your performance if you had perfect foresight.

As you can see above, even in this extreme scenario with perfect foresight, you would have been better off buying treasuries than shorting equities 3/5 times in terms of Sharpe Ratio and 4/5 in terms of return to drawdown. Bear market rallies are a real phenomenon that hurt shorts.

Now, to look at a slightly more realistic scenario (although still very optimistic). The following charts show the same stats, but instead of ending at the equity market bottom, it shows results as of the bottom plus one month. A reasonable amount of time for anyone following a negative equity trend to determine the trend has changed and get out.

We see now that it’s indisputable!

Unless you have perfect foresight (and even then!) if you think a recession and equity market crash is coming then it’s a much better strategy to go long bonds rather than short equities.

Of course, to get the same level of risk from treasuries as you would from equities you have to use leverage. Nowadays this is simple to do either through the use of futures or leveraged ETFs. Anyone thinking about timing markets should be comfortable using reasonable amounts of leverage (2–3X for treasuries).

With volatile markets and slowing growth worldwide this is a good stat to keep in mind.