Practical Steps to Beat the Bear

Charlie Toole:

What should an investor do in a bear market? Join us as we discuss three simple but not easy steps to avoid a financial mistake when stocks drop. Hello, I’m Charlie Toole, a portfolio manager at Adviser Investments. And welcome to another The Adviser You Can Talk To Podcast. Joining me today is Jeff DeMaso, our director of research at Adviser Investments. Jeff, welcome.

Jeff DeMaso:

Hey, Charlie, how’s it going?

Charlie Toole:

It’s going very well, especially after what the markets did last week. If you weren’t paying attention, we entered and exited a bear market. So after back-to-back weeks of 5%-plus losses in the S&P 500, stocks were up over 7% last week, and I think this is pretty typical for a bear market. You have swift losses followed by even swifter gains. And Jeff, we’re going to talk about three steps that investors can take right now to help them achieve their financial goals through a bear market. I think that the things we’re going to talk about is one, don’t panic; two, understand what’s driving the volatility; and three, think long term, not short term. And these are, I think, three pretty simple things to do. But even though they’re simple in a bear market, they’re sometimes hard to do.

Jeff DeMaso:

Yeah, simple doesn’t mean easy.

Charlie Toole:

That’s right. So the first one’s don’t panic, right? If stocks are falling—as I said, back-to-back weeks with 5%-plus losses—I think there was a stat that stocks were down 10% in a five-day period, which is pretty unique. But if you make a bad decision during those time periods, it can do some financial damage.

Jeff DeMaso:

Yeah, I agree, Charlie. Bear markets are really tough. In a bull market, everybody thinks that they have a really high risk tolerance. And sometimes in a bear market, you find out that you actually didn’t have that high of a risk tolerance. You aren’t as comfortable with that much stock in your portfolio. The balancing act here is, as you said, you don’t want to panic. This is often when investors make a really big mistake and go all to cash after riding the market down. So it’s a balancing act of being aware of your risk tolerance but then also being aware of where we are in the market cycle. And it’s rational to be concerned and anxious during bear markets.

Jeff DeMaso:

One trick I try to use when thinking about bear markets and volatility is don’t think of them as this penalty that you’re paying or you’re being punished or anything like that. No, that’s not the way to look at it. Think of this volatility as just the fee you pay to be in the market, that you pay to compound your money. No, that doesn’t mean you need to be 100% stocks. We can find a little bit of balance. But I think you just got to think about, again, you’re not being penalized for being in the market. This is natural, this happens. And we’ve been here before and we’ve come through the other side.

Charlie Toole:

Exactly. As you said, recessions and bear markets, they’re part of investing. And while the selling might make you feel better at that moment in time, it’s going to do more damage over the long term. I know we talk a lot about missing the 10 best days and how just missing 10 days over a 20-year period can really hurt your returns. I think it cuts returns by more than half, and those are just 10 days in the market. And usually those 10 days happen in and around bear markets because there’s such a quick reversal back to the upside, as we saw last week.

Jeff DeMaso:

Absolutely. And as you said, volatility is kind of highest. The worst returns also happened around those times, too, so it’s challenging. So let me offer just another stat or argument for why you might want to try and stay the course a little bit here. So this year has been particularly hard I think for conservative investors because the bond market has been hit so hard. This year’s interest rates have gone up. Bond prices have come down. And a lot of conservative investors are looking at their portfolio and saying, “Why am I down so much? Why aren’t bonds helping me?”

Jeff DeMaso:

So if you think about that classic balanced portfolio, that’s 60% stocks and then 40% bonds, it’s down 16% this year. And that’s a lot to stomach in a six-month period for people that think they’re balanced. So I went back to look at the record over history and went from the end of 1949 to today, and I saw that there have been 15 times when that 60/40 balanced portfolio fell 10% or more in a six-month period, and that’s not counting the current period. This is the 16th time it’s happened. So it has happened. It’s rare, but it has happened before. But I said, “OK, once you’ve been through that difficult six-month period, what happened going forward?” And over the next 12 months, the average return from that 60/40 portfolio was 18%. That’s a pretty strong return from a balanced portfolio in a 12-month period. And on top of that, it was positive every single time. So disclaimer here, past performance is no guarantee of future results. It’s not a guarantee that 12 months from now, we would necessarily be higher. Again, a lot of things could happen. But there’s a nice bit of historical evidence that staying the course, even extending your time horizon just out 12 months, might help recover some of the pain that we’ve been through recently.

Charlie Toole:

That’s a great point. And I think it gets into our third point, which we will get into, about focusing on the long term. And we’ve seen a number of these. You did that research on the 60/40 portfolio. We’ve seen things—I think Bespoke had some returns over what happens after the S&P falls 5% in back-to-back weeks, and it’s the same story. If you look out a year later, I think the market’s up on average somewhere in that high-teens percentage, and the positivity rate is also very high. I think it was around 90% positive one year later. 90% of the times, it was positive one year later.

Jeff DeMaso:

Oh, absolutely. Part of the message of those stats is really just when it feels the worst, when stocks are really getting hammered, is often the times you want to be buying. Although of course doing it at that time is really difficult. But maybe then that leads us to try and talk about point number two: OK, if we’re saying stay the course, try and extend your time horizon. Well, maybe it helps them to understand what’s driving the volatility today. What’s going on? What’s happening in the market?

Charlie Toole:

Absolutely. I think as an investor, if you know what’s causing stocks or what’s causing bonds to drop in price, you can at least understand what’s going on. And really there’s a lot going on, not only this year but the last two or three years. And I think that’s the first point that we have here is that COVID impacted inflation and caused some unexpected inflation. Whether it’s lockdowns in China, supply chain issues, the delta variant, the omicron variant, things happening where economic activity all of a sudden slows, people don’t want to go to work, people want to stay home—a lot of these things impacted inflation. And now we’re seeing inflation readings in the high single digits. That’s something we haven’t seen in over 40 years. And it’s impacting prices, it’s impacting what consumers have to pay, it’s impacting bond yields and it’s impacting what the Fed has to do.

Jeff DeMaso:

Yeah, inflation’s been really hard. It’s definitely crimping the driver of the U.S. economy, the U.S. consumer. If they’re spending more at the pump, if they’re spending more at the grocery store, that leaves less to spend in other places. And look, I think it’s no wonder that sentiment is kind of in the dumps, to use a technical term there. But whether it’s investors, consumers, small businesses, everyone is really, really negative right now. And add into the inflation the geopolitical concerns—I don’t like the term COVID fatigue, but it’s definitely worn on all of our collective psyches. We’re not worried about are we in a recession or is there one coming? So it’s really understandable why people are very negative today. I guess I would kind of point out that all those things are known and that maybe leads to, like, what’s being done about them. Is there any positive we can take from that?

Charlie Toole:

Yeah. Well, I think the Fed is raising rates aggressively, but we’re starting to see some things ease. China’s lockdown earlier this spring was certainly something that impacted the supply chain. Well, now they’re reopening, so you’re seeing some signs that the supply chain will ease a little bit. We’re also just seeing some signs that prices are coming down. Oil’s down 15% in the last week and a half. A lot of other commodities, whether it’s lumber, nickel, copper, natural gas, they’re falling even more. So you’re starting to see the impact of what the Fed has been doing. Rising rates creep into prices of commodities. You talk about consumer confidence—that’s highly linked to the price of gas. So gas prices I think have peaked and have started to come down a little bit—not a lot—which we’re entering summer driving season. But I think that could go a long way toward easing consumer concerns, if you start to see gas prices come down as well.

Jeff DeMaso:

Yeah. And I think what I’m hearing is that this is a really difficult environment to figure out what the road ahead looks like. Now, I always think that’s the case. In hindsight, we always go, “Of course, of course it was going to go that way.” But it’s always difficult to do it. But I think in this moment where you have the impact of COVID and how that skewed the economic data in such a wide degree both up and down. You had inflation. You have the impacts of lockdowns in China, sanctions against Russia. You have the Fed tightening rates. You have kind of all these things on one side. On the other side, we still have a very tight labor market, high level of employment. To your point, there’s some signs that inflation may be coming down. I don’t think we want to hang our hat necessarily on that call, but we’re seeing those signs. So you have these, again, on one hand, on the other hand.

Jeff DeMaso:

And so how do we translate that into portfolios? I think it’s more about being a little bit neutral, trying not to take a big bet on just one outcome. It’s being positioned to do reasonably well, given various different outcomes that we could have down the road. And that’s kind of more from a strategic standpoint. If you’re thinking tactical, hopefully you have a plan in place already and your portfolio’s following that plan.

Charlie Toole:

Absolutely. It’s the only free lunch in investing—diversification. And I don’t think any one of us is smart enough to pick the one asset class that’s going to do the best. So you do have to diversify and not put all your eggs in one basket. But I think that’s a good transition to our third point here, which is think long term, not short term. Investors, on the day to day, you can get focused on what the market’s doing today or what the market’s doing this week and not take a step back and say, “All right, what has the market done the last year, the last three years, the last five years? Am I on track for what I want to accomplish financially or am I not?” And it’s really about long-term goals, not short-term market price movements.

Jeff DeMaso:

Couldn’t agree more, Charlie. It’s all about coming back to that financial plan. Because look, if we’re talking short term, if you have something that you need to buy in the next three, six, 12 months, that shouldn’t be invested in the stock market anyway because there’s such a wide range of what can happen. So when we’re talking about your investment before that, we are talking about long-term goals. And there you want to have a financial plan that when you run, it’s going to take into account that bear markets happen and it’s going to expect difficult markets. So even though we’re down now, you might very well still be on track. And if not, you want to check in and see if you need to make any course corrections. And if you don’t have a financial plan, this is a great time to talk to your adviser and think about working on one to give you that confidence to look long term and not focus on the short term.

Jeff DeMaso:

Can I offer a couple tricks I have about the market, too? Think about it not as a penalty or punishment but as a fee. Two other things I just have. When we’re in a bear market, how do you try and think long term and focus beyond just a short-term gain? So one thought is if you can, if you look back at past bear markets, you go, “Oh, that was a great buying opportunity. Oh, if only I’d bought at the bottom in March of 2009” or “Of course I should have bought it in the beginning of April, coming out of COVID.” Well, we’re in a bear market today. Chances are down the road, we’re going to look back and say, “Oh, that was an opportunity.” So that’s one way to think about it.

Jeff DeMaso:

Another thought: “All right, not a lot’s going on sale right now because inflation’s going up and everything seems to be getting more expensive.” But usually when something is on sale, people rush to buy it. When was the last time you saw someone run away from a Black Friday sale? It doesn’t happen. People run into them. The stock market is like the one place where that doesn’t happen, where lower prices make people panic and want to get out when maybe they should think is that the time to come in? Maybe you have to do it with discipline. You’ve got to dollar-cost average or something because there’s no guarantee that things don’t go more on sale. And again, I’m not trying to call the bottom here. I don’t think there’s a lot of value in that exercise. But it’s about thinking about the long term, thinking about if you are on track for your financial plan and if not, what adjustments you need to make to get there—and then trying to provide some of these mental tricks to help focus on that long term and get away from just short term.

Charlie Toole:

Absolutely. And for our younger investors out there, or even the listeners that are still working, keep contributing to your retirement accounts. I think that was one of the biggest mistakes I saw some friends make back in 2008, 2009. They stopped contributing in late 2008, 2009, because they thought, “Hey, I was losing money every time I made a deposit in my 401(k).” Well, to your point, that’s when you want to buy. That’s when stocks are on sale. You look back, that was the buying opportunity. And a lot of people just stopped buying at that point. If your investment plan is to keep every paycheck by putting the money into your 401(k), putting money into your 403(b), continue to do that. This is the best time to be doing that because to your point, this is going to be looked back upon as a good buying opportunity.

Jeff DeMaso:

Yeah, again, I couldn’t agree more. Just automating your investment plan in that regard and just having it happen automatically without you thinking about it is such a great way to go about doing it. And dollar-cost averaging is really nice because it means you can’t really be wrong. You’re not going to be 100% right. But if this is the bottom, OK, at least you were buying some and you’re there to participate. But if stocks keep going down, well, you still have the opportunity to buy more shares at lower prices. So it gives you kind of a win-win if you want to look at it that way.

Charlie Toole:

Absolutely. All right, I think these three steps, as we said, they’re simple, but they’re not easy. But if investors follow these steps, they’re less likely to make a financial mistake in a bear market. So remember, don’t panic, understand what’s going on, and think long term. So, Jeff, I think we’ll wrap it up. So thank you for joining me today.

Jeff DeMaso:

Always a pleasure, Charlie.

Charlie Toole:

This has been Charlie Toole and Jeff DeMaso from Adviser Investments thanking you for listening to The Adviser You Can Talk To Podcast. If you’ve enjoyed this conversation, please subscribe and review our show. You can check us out at adviserinvestments.com/podcasts. Your feedback is always welcome. And if you have any questions or topics that you’d like us to explore, please email us at info@adviserinvestments.com. Before closing, I’d like to thank Kailey Steele and Ashlyn Melvin. They do all the hard work making this podcast possible, so thank you. And thank you for listening.