Are You Prepared for the Next Bear Market?

To be clear, the title of this article isn’t a prediction that a bear market is imminent.  In fact, there are a lot of reasons to think it may be a while before the next full blown bear market which would be marked by a 20% or greater decline.

The US economy is still growing at a faster than average rate as the recovery from the global pandemic shutdown continues.  Additionally, there are segments of the stock market that haven’t moved up as much as other parts of the market during the recovery from the COVID-19 bear market.  Finally, despite steps by the Federal Reserve to begin tightening, monetary policy remains accommodative and will likely remain so for some time. Fiscal policy in the form of increased government spending is also still providing fuel to the US economy.

There are certainly risks, but a bear market in the near term is not a forgone conclusion and many market prognosticators remain generally upbeat.  However, with the considerable strength the US market has enjoyed since April 2020, a market pullback or correction of 10% or more in 2022 shouldn’t come as a surprise. After all, history has shown that on average since 1980 the market (as measured by the S&P 500) experiences an intra-year decline of approximately 14% each year (see image below). Predicting when a correction will start or when it will end is incredibly difficult.  Historically, corrections haven’t lasted very long and disciplined application of an investment structure is the best way to navigate the temporary weakness.

Investors cannot invest directly in an index

So, how can you prepare for the next bear market, whenever it may come? There are a couple of steps we’d recommend.

First, having realistic expectations for portfolio performance can go a long way.  To state the obvious, the purpose of stock exposure in a portfolio is to produce returns.  In exchange, we as investors must accept the price volatility that goes along with it.  It is common for the US stock market to have a negative return about one out of every four years.  So, if we want higher potential returns, we need to accept the temporary declines that will periodically occur.

Second, we’d recommend confirming that your portfolio structure is appropriate.  The S&P 500 had 70 new highs in 2021 (the second-highest figure ever, only behind the 77 all-time highs in 1995) and ended the year near its all-time high.  With returns of 18.4% and 28.7% respectively in 2020 and 2021 this may be a good time to shift some of your equity exposure to more stable assets if you would be more comfortable with less risk in your portfolio.  While we don’t expect volatility control assets like bonds to produce as much return, they should better help preserve what you’ve accumulated.

Many investors react to market weakness by reducing their stock market exposure during a bear market.  That can be a very destructive course of action, making permanent what otherwise could be temporary losses.  Investors can reduce the time it takes to recover from the inevitable periods of stock market weakness by maintaining their investment structure and even buying more stock exposure through disciplined rebalancing, which we regularly do for clients during market declines.  As the founder of our firm Bryan Brand said, “decide in the light what you’ll do in the dark”.  Applying a previously determined Investment Policy Statement during periods of market distress allows us to do exactly that.

Finally, a word to our clients: we make it a point to talk with you during our reviews about the structure of your portfolio and whether you’re still comfortable with it.  We also proactively suggest modifications when we think they are appropriate.  If you’re unsure about your portfolio design and would like to discuss it with one of our advisors, please let us know.  In addition to discussing your comfort with the level of risk in your portfolio we’ll also evaluate your ability to achieve your stated goals with a potentially lower level of risk.  If we determine that an adjustment is appropriate, we recommend implementing a change during a period of market strength instead of weakness.

“With a good perspective on history, we can have a better understanding of the past and present, and thus a clear vision of the future.” — Carlos Slim Helu.

Our team is equipped to help you navigate every season of the markets and we know what we’ll do in each of the ups and downs. Take it from us: we’re ready for whatever may be coming our way.