The Awakening of a Bear

2Q 2008

As the second quarter began, investors held out hope that the worst of the credit crunch was over, and that stocks would rise as the economy regained momentum late in the year. On April 1st, the S&P 500 actually appreciated by 4.1%, and by mid- May the index was within 1.9% of being back at break-even for the year. However, the reprieve from fear and worry proved to be short lived as the effects of the credit crisis lingered and threats to consumer spending have escalated alongside rising commodity prices (broad basket up 29%). The “misery index”, which is a combination of unemployment (5.5%) and headline inflation (5.0%), has ascended to its highest level since 1993.

With June’s decline of 8.4% registering as the worst monthly performance since September 2002, the S&P 500 ended the second quarter down 2.7%. Following its third consecutive quarterly decline, the index most commonly used to represent the U.S. stock market found itself perilously close to the 20% decline from a recent high (October 2007) that’s typically considered the mark of a bear market.

To be sure, this detail did not escape the media’s tireless attention. Amidst this intense coverage, and the self-fulfilling prophecy that we’ve previously hypothesized may result from such, the S&P 500 (along with other stock indexes across the globe) has subsequently fallen into official bear market territory. Make no mistake about it, these have been ugly days, perhaps far uglier than even the indices suggest.

The good news is that bear markets are nothing new. As we’ve spent some time recently scrubbing historical returns data, it’s worth noting that this would be the 13th bear market for the S&P 500 since 1928. In the previous occurrences, a full third of which happened to fall during the Great Depression, the average stock market decline came in at nearly 38% and the duration of the downturn (peak to trough) was roughly 17.5 months. While a pessimist may look at these figures and say that we still have a ways to go, investors have always found it difficult to time the market’s bottom. They surely don’t ring a bell to mark the onset of a return to growth, which by the way has been exceedingly strong following past bear markets (averaging greater than 41% in the subsequent 12-months).

The point to realize here is that the bulk of the pain for investors is likely already behind us not ahead of us. If you have a twelve month or more time horizon, chances are good that today is a far better buying opportunity than a time to sell. In many cases, we’ve done this for you through rebalancing out of fixed income and into stocks. Investors who panic now, and flee to the relative safety of bonds or cash, may only compound their problems by missing the next springboard.

The other lesson for investors, of course, is the benefit of adequate diversification. While we’ve focused almost entirely on the S&P 500, no portfolio under our management marches in lock-step with this single slice of the global marketplace. Believe it or not, several asset classes actually appreciated in the second quarter (Growth stocks, Small & Mid Cap stocks, and Muni bonds are examples). We continue to believe that there isn’t enough “bad news” to make a long-term and well diversified strategy fail. We’ve experienced markets like these before, and we confidently await the return of better times. We certainly hope that you share our outlook.