Q2 2022: A Bear Market Toolkit

After last quarter, most major stock indices are down 20% or more from their recent highs. Thus, for all intents and purposes, we find ourselves in a bear market. Over the past few years, we faced some down markets, namely the “Bear Cub” market of 2018⁴ and the COVID-inspired crash in early 2020. Although certainly unpleasant, in both cases equity markets resumed their upward climb in rather short order. This bear market, however, has persisted since the beginning of the year, perhaps unsettling investors more than the previous two.

We don’t know how long the bear market will last. As of this writing (July 29), stocks and bonds are both up since the end of Q2. We hope July’s returns represent the “tail” of the bear. But we see no shortage of reasons for pessimism: inflation, energy supply, lower corporate profits, and/or rising interest rates could push stocks and bonds lower. Bottom line: we may already be out of a bear market, or we may have to hunker down for some time.

If the latter, what can we do? We don’t believe in making material portfolio changes in our around market volatility for two reasons. First, investors often base their decisions on their feeling state. Emotion and finance, however, don’t mix. We run a heightened risk of making a poor decision that may impact our long-term financial security. Second, such changes are necessarily based on past events. Just as no one would recommend driving by looking in the rearview mirror, we don’t recommend portfolio changes based on the recent past.

Instead, we recommend deploying our “Bear Market Toolkit.” We believe the Toolkit provides guidance to investors and can help “navigate” a bear market. Mark Johnsen, our CEO and Chief Wealth Architect, often likens long-term investing to taking a long boat trip. We believe it’s an apt comparison and will borrow liberally from (i.e., steal) his metaphor here. Today we’ll explain each tool in the kit within the context of a maritime voyage.

Tool #1: A Long-Term Strategic Plan

Mark’s metaphor resonates, at first blush, because investment volatility can feel very much like an open-sea voyage. Storms batter. Waves propel. Sea creatures lurk. Uncertainty abounds. Sometimes the trip is so jarring that we become seasick.

That’s why we believe a financial plan is essential to successful investing. The plan represents our destination. It’s also our map and, in dark times, our North Star. Just as no one would begin a long cruise with no destination, we feel no one should invest without a purpose. Moreover, we can consult the plan from time to time, reminding us of why we’re navigating uncertain waters: it’s the best way to reach our destination.

Tool #2: Perspective

We believe perspective is also an essential tool. Successful investors place difficult markets within a broader context. We should expect some large waves when crossing the ocean. Similarly, we should expect bad markets when investing for the long term. Double-digit stock declines are much more common than most realize. Since 1979, as this chart shows, the average intra-year drop has been 14%. Put another way, investors can expect, on average, a “three-quarters bear market” each year. Despite the substantial intra-year drops, the US stock market has ended higher almost 84% of the time since 1979.

We recommend investors take great pains to apply perspective during bear markets. Down markets are natural and common. In fact, market volatility is the key to equity investing: We willingly take on the short-term risk of a bear market for higher expected returns over time. If stocks never went down, everyone would pour money into them, bidding up prices and lowering expected returns. Maintaining perspective can help keep this top-of-mind.

Tool #3: Patience

Even though bear markets are common, even necessary, they are painful. Patience can help blunt that pain. Those who take ocean cruises know the accommodations aren’t the same as home. Even the nicest vessels tend to have small staterooms, slippery decks, crowded lunchrooms, screaming children, closed plumbing, and a host of other inconveniences.

If we dwell on those discomforts and allow ourselves to get angry or upset, we’re in for a miserable trip. Conversely, seasoned travelers focus on other things: magnificent views, the smell of sea air, or new ports of call. Even though they experience the same downsides as everyone, happy passengers patiently choose to focus on the positive.

We can’t control capital markets any more than we can control the ocean. But we can control our thoughts and feelings. Impatient investors check their balances daily, consume lots of financial media, and probably feel miserable. We recommend approaching bear markets patiently. Resist the urge to look at your portfolio. Find other things to focus on. Remind yourself that bear markets aren’t personal and, tough as it is, try not to get upset. The more patient we can be, the more pleasant the trip.

Tool #4: Perseverance

One frustrating aspect of long-term investing: it takes a long time. Much like a trans-oceanic trip, successful investing requires us to stay on course. Through thick and thin. Through storms. Through bear markets. Our financial plan represents our financial lifetime path. We save. We invest. We wait. Success requires us to persevere.

Mariners don’t “jump ship” in the middle of a voyage. Regardless of how much open-sea turbulence they face, sailors understand the alternative is much worse: abandoning your course and drifting alone, directionless, in the middle of the ocean.

Same with investing. During bear markets it’s natural to want to stop the volatility and get out of the markets. Unfortunately, we don’t believe jumping ship is productive. In fact, many investors who do so find they feel no less stressed. That’s because the question “how long will this bear market last?” gets replaced by the equally stress-inducing “is today a good time to get back in?” All the while, those sitting on the sidelines are no closer to their destination.

Fortunately, bear markets tend to be relatively short. As this chart shows, since 1926 the average bear market lasted less than 10 months versus an average bull market duration of 54 (!) months. A bear market, no matter how short, isn’t pleasant. Yet if we persevere, we are likely to see clear skies in the near-ish future. The next bull market never seems to be too far away.

Tool #5: Partnership

Even the most grizzled sea dogs don’t do it all themselves. A successful passage requires a focused, disciplined team. When storms batter the ship, no one says “Hey, let me take the wheel and I’ll give it back when things clear up.” That could lead to disaster. Instead, every voyage has a captain and crew. Each person has his or her own area of expertise and helps keep the craft on course. Experienced sailors know how to navigate the most difficult storms.

So too with investing. We believe partnership is the key to financial success. Our clients set the destination. As advisors, we map the course and steer the ship. When storms (bear markets) inevitably arrive, it’s “All hands on deck.” Together we talk, we review, and we help ensure you have sufficient liquidity. But we resist the urge to change course. The better the trusted partnership, the higher the chance for success.

No one enjoys a bear market. They are stressful for clients and advisors alike. We can’t promise your investing future will be free of bear markets. Instead, we strive to be your trusted crew, helping you navigate very rough waters. Moreover, we believe this Bear Market Toolkit can help blunt the emotional impact of the next downturn. Together, we hope to make your journey a little bit smoother.

¹ US stocks represented by the S&P 500 Index. Source for all investment returns unless otherwise noted: Morningstar. Past performance is no guarantee of future results.
² Developed-markets stocks represented by the MSCI EAFE Index (Net). Emerging-markets stocks represented by the MSCI EM Index (Net).
³ US bonds represented by the Bloomberg Barclay’s Aggregate Bond Index.
⁴ See 2018 in Review: The Year of the Bear Cub, Wealth Architects, 2019.

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