We went for a bike ride this past Christmas Day on the Farmington Canal Heritage Trail in Farmington, Connecticut. It really is quite a nice trail. We have never been on a bike ride on Christmas Day as the temperatures in Hartford County are rarely in the low 60’s at the end of December.
We started down the path and my daughter who was ahead of me started screaming, ” A Bear, A Bear, A Bear!” I’m thinking to myself, it’s Christmas Day, aren’t the markets closed today? And then I’m thinking what does my daughter in college know that I don’t know? Sure enough I caught up with her and there was the mother black bear and her two baby bears strolling through the woods. This was the first time I had ever seen a black bear not in a zoo. It was quite a sight to see. We kept biking down the trail but I couldn’t stop thinking about the bears and my first thought…what about a Bear Market?
A Bear Market
A Bear Market is defined as a decline from a recent high of 20% or more. We have not had a Bear Market for some time. Check that, for a long time. The last Bear Market was from October 2007 to March 2009. This Bear Market lasted seventeen months in duration. The Standard & Poor’s 500 Index (“S & P 500 Index”) lost 56.4% during this time period. Ouch. That hurts. A more modest declines is called a correction. A market correction is defined as decline from a recent high of 10% or more. The stock market did finally correct in the summer of 2015. This is the first correction since the Great Recession of 2008-2009.
To measure a Bear Market you would need to use an index and compare the high to the low close. The most frequently quoted index in the media is the Dow Jones Industrial Average (“Dow”). When investors want to know how the market did they are generally discussing the Dow. The Dow has a limitation however. There are only thirty stocks in the Dow. That’s it. It’s a fairly small sample size. It doesn’t necessarily represent the broad market.
The next most common index used is the S & P 500 Index. This index has 500 stocks in it. As such it provides a much broader index for the market as a whole. The third most common index is the NASDAQ. This index has a lot of technology companies in it. Therefore this index is a good proxy for the technology sector. Above we mentioned the S & P 500 index decline in the last Bear Market as this serves as a proxy for the broad market. The Dow and the NASDAQ also had significant declines.
A Bull Market
The opposite of a Bear Market is a Bull Market. A Bull Market in the stock market is when prices are rising or are expected to rise. The most recent Bull Market started in March of 2009 when the Dow was at 6,547. The Dow reached a high of 18,312 in May 2015. The Dow closed at 17,425 on December 31, 2015. The S & P 500 Index closed at a low of 666 in March 2009. It closed on December 31, 2015 at 2,044.
The good news is that a Bull Market typically lasts a lot longer than a Bear Market. On average a Bull Market lasts 97 months. A Bear Market only lasts about 18 months. That’s the good news with Bear Markets. The less than good news is that the average Bear Market decline is about 40%.
What Can You Do About a Bear Market?
Adjust your asset allocation. The key word here of course is adjust. Wholesale changes should not be made to your investment portfolio. For example, assume you are currently investing 60% in equities, 35% in fixed income and 5% in cash. If you were concerned that the market was fully valued or even over valued you might consider decreasing your equity exposure. For example, you might change your asset allocation to 50% equities, 40% fixed income and 10% cash. This would reduce your equity exposure and increase your fixed income and cash.
Invest for when you need the money. This is what investing is all about. You will have financial and life goals. Perhaps it’s to buy a car, a house and pay for your children’s education. I suspect almost everyone has a goal to retire someday. All of these goals will have a timeline associated with them. This is when you will need the money. If you were saving up to buy a car or a house in say the next three years you wouldn’t want to invest these funds. You would want to save your money and put it in something such as being less volatile and lower risk. You are not in a position to invest as you will need these funds in three years. If you have longer term goals like paying for your children’s education and retirement, these funds can be invested as you will have a longer timeline. Generally you should have financial goals that are five years or more away to be investing. This generally allows you to invest through an economic cycle.
Get Off the Information Highway
Anecdotally it seems that many people value the most recent information they have received as being more important than any other information they already had. Oil is going back to $100 a barrel. It’s time to buy some oil stocks. Gold is headed to $1,500 an ounce, better buy some now. Interest rates are rising, so don’t buy bonds. Why is this new information perceived to be more valuable? It might have to do with people’s memory. Face it, as we get older our memory tends to not be as good as it once was. So, when some new information comes our way it seems, well, more important.
The other primary reason is the media; they need to make a story out of everything. Watch the news, listen to the radio or read the newspaper, and you’re bound to hear or read how stocks rallied or sank that day. This helps promote how important this one particular day was. Does a one-day, 100-point move in the Dow really matter? It shouldn’t. With the Dow trading around 17,000 now, a 100-point gain or loss is a little more than one -half a percent. Not a big deal and it’s only one day. If you started investing in the stock market at age 20 and stopped at age 70 (certainly not what I would recommend), there are about 13,000 trading days over your 50 years of investing. Is one day going to make a difference in your life? Probably not. Ignore the daily market fluctuations and all the media attention it gets. I know, this is easier said than done. With information available 24 / 7 it’s difficult to stay away from all this news. Think about it; is there any competition in the media to have the latest story, angle or insight? How are they going to fill up all the time slots? Well, um, I think that well; maybe there’re going to hype the stories to get your attention! What do you think? Are they going to be like Joe Friday and ask for, “Just the facts, Ma’am?” I don’t think so. You’ll have to read or hear how the market soared, going up 179 points that day. The next day you’ll hear how the market crashed by going down 123 points. Like the Energizer Bunny, this just keeps going and going and going. Take it for what it’s worth.
What do you need to do? Start by turning off your TV, computer and radio and canceling the subscriptions to all of your newspapers and magazines…just kidding (sort of). Honestly though, you probably should reduce the amount of daily information taken in. Design a system that filters out most of this “noise.” This system should block out much of this unnecessary information. This noise isn’t limited to financial matters. It stretches down the street, around the globe and back into your neighbors’ driveway. Less is definitely more here. This is addition by subtraction. This system should only allow relevant information in. After this system is in place, then what? Get a couple of good books, throw a few logs on the fire and enjoy. Which books should you get? Peter Lynch has written a few great books, One Up on Wall Street and Beating the Street. He was the former manager of the Fidelity Magellan Fund and had an outstanding record. His books simplify investing principals that can be applied by most investors. Peter Bernstein wrote Against the Gods: The Remarkable Story of Risk and several other excellent books. Risk was a concept that many investors forgot about during the late 1990’s. The all time classic however is Benjamin Grahams The Intelligent Investor, which describes value investing at its best. Mr. Graham was a professor of Warren Buffet who apparently was a pretty good student. For periodicals, only subscribe to two or three newspapers and magazines. I like reading the Wall Street Journal and their sister publication, Barron’s on the weekends.
Retirees and Pre- Retirees
Retirees and Pre-Retirees need to be cautious. This doesn’t mean they should liquidate their investments and take the cash and stuff it in a Folgers coffee can and bury it in their back yard. They still need to maintain a diversified investment portfolio to help meet their goals and objectives.
While there were lots of lessons learned from the Great Recession from 2008-2009 the biggest one was:
The Sequence of Investment Returns Really Matters
This is especially true for retirees and pre-retirees. An extra step that retirees and pre-retirees need to do is to have at least two years of living expenses in a money market account. For investors that had this in cash reserves during the Great Recession many escaped with minimal financial damage. For many investors that didn’t have this cash reserve it was a very difficult time. If someone retires and the market has double digit negative returns for several years while you are taking distributions from your portfolio this can decrease the value of your portfolio so much that may be difficult to recover from. This is why the sequence of investment returns is crucial for the newly retired. Having at least two years of living expenses in a money market account may allow you to leave your investment portfolio relatively unchanged and not be forced into selling positions when the market is down.
“Blue Light Special”
The good news with a Bear Market is that stocks are on sale. For investors in the accumulation phase a Bear Market becomes a buying opportunity. Warren Buffet, Chairman and CEO of Berkshire Hathaway and one of the richest individuals in the world with an estimated net-worth of $67 billion said, “Be Fearful When Others are Greedy and Greedy When Others Are Fearful.”
Future Bear Markets
Most market predictions are not worth the paper they are written on. Here is what we do know. There have been Bear Markets in the past. According to CNBC there were eleven Bear Markets beginning with the Great Depression of 1929. Some were brutal. There may likely be Bear Markets in the future. Some may likely be brutal. When will they occur? We don’t know. How much pain will they inflict? I’m not sure, but for investors that sell out near the bottom, I suspect a lot.
Investing involves risk and you may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stock of companies maintained and reviewed by the editors of the Wall Street Journal. The NASDAQ composite is an unmanaged index of securities traded on the NASDAQ system. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance doe not guarantee future results. The above hypothetical examples are for illustration purpose only and do not represent actual investments. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. Investments mentioned may not be suitable for all investors. Prior to making an investment decision, please consult with your financial advisor about your individual situation.
The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Thomas F. Scanlon, CPA, CFP® and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice.