May 10, 2022
According to the National Park Service, when you encounter a bear, you can help protect yourself by following a few simple steps.
- Remain still.
- Stand your ground.
- Slowly wave your arms.
- Stay calm.
- Do not run.
Further, the NPS advises that every bear and every experience is unique. Most end without injury.
There are of course more safety tips, but these five pieces of advice are tips that should also apply to the well-prepared investor spotting a bear market (defined as a 20% or greater decline in the value of the stock market) looming on the horizon. I will elaborate on “well-prepared”, as it is a key element in bear market portfolio safety.
Human nature in a market decline is very similar to an encounter with a bear in the woods. As fear takes over, the logical part of our brains takes a back seat to base instincts. Flight response is natural but must be subdued for your portfolio to remain intact.
As is the case in every bear market or significant correction that I can remember, the news media is unlikely to offer you much perspective or comfort. Like a bear appearing on the trail in front of you, the news of the day is likely to provoke more fear. The natural human reaction would be to run wildly in the other direction, selling all of your assets as the bear market devours your wealth.
Remain still. Stand your ground. Wave your arms if you want. Stay calm. Do not run. Think.
We are amid a stock market correction approaching the 20% bear market threshold. On January 4, 2022, the S&P 500, a cap-weighted index of 500 large US companies, topped 4,818. As inflation data, ongoing supply chain disruptions, and geopolitical turmoil made headlines in early 2022, the market has declined, recovered, and then declined further. As of this afternoon, the index has fallen 17.2% to 3991.
The “well-prepared” investor who remains calm and thinks, can survive without injury. Look back at your financial plan. Weigh your time horizon. Review your asset allocation. Do you have the time to allow your portfolio to recover? If you can’t answer this question, then you should review your plan with your financial advisor. Helping you through these times is your advisor’s job. Reach for the phone. Schedule a conversation.
We walk through the woods and hike mountains for the pay-offs: Stupendous views, quiet moments, fresh air. We invest for the financial pay-off, as well. Over long-term periods, equities have averaged 5-6% over the rate of inflation. To pursue these pay-offs, we must accept the risks, including the occasional bear encounter. Be prepared.
Will the stock market recover?
The stock market does not come with a guarantee. According to Investopedia, there have been 26 S&P 500 bear markets since 1928 (before the great depression). They have ranged in severity from a 20.6% (1990) to 51.9% (2008-2009). They have lasted from 1 month to 1.7 years. Every prior bear market has been followed by a full recovery. Since 1928, and including all 26 bear markets, the S&P 500 has averaged over 10% per year. We fully believe the market will once again recover. How long it will take is unknown.
Will rates move higher, or will inflation come down?
The Fed faces a dilemma. The board seeks to control inflation by increasing the Fed rate (the rate at which banks make short-term loans to other banks), but the Board does not want to move so fast that they put the economy into recession. How this dilemma will play out is uncertain, and these uncertainties underscore the importance of investing with the proper time horizon in mind.
Inflation may be eased in other ways. If supply chain issues improve, then product scarcity may allow prices to return to normal. Supply shortages may limit the effectiveness of rate increases on taming inflation while they continue. For this reason, the Fed may be conflicted as to the best course of action.
Bonds are down also. Should I be worried?
Most bonds are fixed income instruments. They have a known interest payment and a known maturity date. As interest rates rise, the price of existing bonds decline, but the income and maturity value do not change. In this way, they continue to offer protection to your portfolio. Your dividend and interest will gradually reinvest at higher interest rates. Maturing bonds will also be invested at higher rates.
What should I do with excess cash on the sidelines?
We will never know in the moment that we are at the bottom of the market decline. All we know today is that the S&P 500 is priced 16.5% lower than it was on January 4th. Before deciding how to invest your cash, or to continue to hold it, review your financial plan. Know exactly when these funds are needed. If they serve as your emergency reserve, then do not put them at risk. Speak with your financial advisor about the best use of these funds in the context of your financial plan.
Michael Fogarty, CFP®