The ghouls of Halloween are gone but the spooky thought of a bear market keeps rising from the mouths of occasional Wall Street experts.
Make no mistake, fear within the U.S. stock markets is causing volatility to reappear after two quarters of relative peacefulness. From rising interest rates to international issues like trade wars and election concerns, the last few weeks have been a bit bouncy in our markets – including pretty hefty point swings intraday.
Volatility is normal. A mistake that often needs “corrected” is that these big point swings in markets do not typically indicate a bear market.
A stock market correction? Sure, these happen on average at least once a year where a 10 percent decline will occur. A 10 percent decline is the definition of a correction.
For the record, no one at our firm is calling for a bear market any time soon and it would be foolish to do so. But we do continually prepare client portfolios for tougher times. In fact, economic data supports the notion that a recession should be pretty far off, in spite of possible headwinds. But, preparation is key.
So what’s so bad about a big bad bear market? Very little if you use a well-planned investment strategy.
First, like those now rotten Jack o Lanterns, bear markets are rotten to experience. Some might compare them to going to the dentist or something similar. For the record, I have enjoyed my dentist visits since Dr. Tully set me on the right path in the mid-1970s.
Others might compare bear markets to being a current Philadelphia Eagles fan. Things seem fine in the game and then the Eagles just blow the game due to poor strategy. Except in a bear market there are indeed strategies that can be consistently used for good.
A bear market is defined academically by a 20 percent or more drop in the stock market. While there have been no overall bear markets in 2018, many stocks have experienced individual bear markets with their stock prices – more of a rolling bear market vs. the entire market participating. For example, some homebuilder stocks are down over 40 percent so far in 2018.
While a 20 percent or higher market decline is alarming, since 1932, a bear market has occurred on average, about every four years. Bear markets are common and should be part of any investing discussion.
Bear markets are typically leading indicators of recession, not lagging indicators. In fact, since 1948, eight of the eleven bear markets have been followed by a recession. We cannot time the end of a recession when stock markets, again, will be a leading indicator of when the recession is over – markets will start to rebound, and often dramatically, from the bottoms of the bear market and form a new bull market.
The average time frame of a bear market has been about 21 months since 1932. Often while the stock side of a portfolio falls over 20 percent, the bond portion might perform decently and help reduce the overall risk in a portfolio.
Rising interest rates? These can help even more since bonds will pay more interest over time and potentially lead to a need for less overall risk.
So, what about when we enter a bear market? Let’s say stocks fall 20 percent and you own a 100 percent stock portfolio. On average, you’ll probably drop at least 20 percent.
What if you are in a balanced portfolio of half stock to half bond? That 20 percent drop pulls you down about 10 percent. But the bonds might rise a little and will pay interest into the portfolio so you might drop only 5 to 7 percent.
If you do what we do and rebalance into the downturn, you’ll truly benefit from a future rebound in the markets. That’s the bigger part of this. Have a strategy in place so that you can work to limit the downside, take advantage of the economic cycle, and kick fear to the curb.
In no case would you sell entirely out – no one had ever perfectly timed markets. Selling is the easy part – determining when to get back in is truly impossible.
And for those saving into a 401k or other retirement plan from each paycheck? Keep doing the same thing if markets head south: you are buying more shares during the temporary downturn.
Patience can truly be tested and stress levels can run a bit higher in a bear market. But like I tell clients, you are paying me to be patient, handle the stress of investing, and remove as much of the worry off of your shoulders. Truthfully, a bear market correction allows a fee-only firm to pull more strings in portfolios.