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The start of a bear, or just a scare?

That’s what many investors were wondering after this week’s big market sell-off, which knocked almost 1,400 points off the Dow Jones Industrial Average in just two days.

Friday’s rally was somewhat reassuring but fell far short of recouping the Wednesday-Thursday losses. And it faltered after a powerhouse start to the day, dropping into negative territory before rebounding in the afternoon. Investors were clearly conflicted, which left everyone speculating about what the new week would bring.

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The underlying causes of the sell-off remain in place: rising interest rates, overpriced stocks, escalating debt, and U.S. protectionism. Plus, there’s the October factor. This is the time of year when markets are at their most vulnerable. The infamous Crash of ’29 occurred in October. Black Monday in October 1987 triggered a 22% drop in the Dow before markets stabilized.

I’ve been saying for some time that this bull is running out of steam and a major pullback is looming.

However, I don’t believe last week’s decline marks the end of the bull – yet. Bear markets typically foreshadow a new recession. There is nothing on the horizon that suggests the global economy is about to go into reverse. Yes, the International Monetary Fund has trimmed its global growth forecasts for 2018 and 2019, but the organization is still predicting increases of 3.7% in both years, down from 3.9% previously. That’s a long way from recession territory.

Moreover, we aren’t seeing any of the corporate and consumer angst that preceded the crash of 2008. There has been no repeat of the Bear Sterns and Lehman Brothers collapses. As far as we know at this point, there is no equivalent of the sub-prime mortgage debacle eating away at the economy (although high debt loads are certainly a problem).

There are worries about weak third-quarter earnings in the U.S., although those were alleviated somewhat on Friday when JPMorgan Chase, Citigroup, and Wells Fargo released results that beat expectations. JPMorgan posted a 24% increase in profits over last year, helped by lower taxes and higher interest rates. Wells Fargo reported diluted earnings per share of $1.13, up 36% from last year. Citigroup posted a profit of $1.73 per share, up about 22% from 2017.

All this seems to suggest that what we saw this week was an overdue correction, not the start of a new bear market.

However, that does not mean you can breathe easy and go back to whatever it was you were doing. This sell-off should be viewed as a precursor of what will eventually happen – an end to this record U.S. bull market and a period of declining share prices, volatility, and uncertainty.

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That means if you haven’t already aligned your portfolio to deal with a profound market change, now is the time. Here are four suggestions.

Take profits. Review every security you own and ask yourself the question: Would I buy it now? If the answer is no, then it’s a candidate for elimination. Of course, you need to consider the tax consequences of a sale if the security is in a non-registered account but weigh the pros and cons of paying the CRA versus the possibility of a sharp decline in the share price.

Be especially cautious with retirement plans. RRIFs in particular should not be overly exposed to the stock market at this stage. The chances of being burned are too high. I suggest that for most people, a RRIF’s stock exposure should not exceed 40%. For people with RRSPs who are less than five years from retirement, that figure should not exceed 50%.

Avoid the fixed income trap. Interest rates are on the rise and that trend is going to continue unless there is a sudden, sharp reversal in the global economy. The means higher yields but lower bond prices. That means so called “safe haven” bonds aren’t really so safe anymore. The FTSE Canada Universe Bond Index is in negative territory for 2018 and that pattern is likely to continue for a while. At this point, a high-interest savings account or a GIC ladder looks like a better approach.

Own some gold. Gold prices shot up as the markets fell last week, and mining stocks followed in lock step. Franco-Nevada (TSX, NYSE: FNV), one of our favourites, gained $6.61 a share (8.3%) between Tuesday’s opening and Thursday’s close. That tells you what to expect when the real market retreat comes.

If you had knots in your stomach as stocks fell last week, you need to take action now. Next time it could be far worse.

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Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters.

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