Want to be smarter than the average bear? Treat the recent mini-correction as a warm-up.
Call it a “bear cub” market. The brief decline in stock prices in late 2018 did not technically count as a bear market—for reasons we’ll get into below—but it did offer a valuable wake-up call. Investors have benefited from a very long rally in stocks (technically the longest in history), and many of your clients may not remember what it’s like to go through a true bear market, where the value of a portfolio can plunge dramatically in a short time.
Yet that experience is coming. It’s impossible to know when, or even why exactly, but a real bear market is inevitable. And when it hits, it will be far more painful and sustained than the bear-cub market we just experienced. As an advisor, you should use that experience as a kind of fire drill—a way to prepare your clients for how to react (or, ideally, not react) when the real thing happens.
Technically, a bear market is a 20 percent drop in the price of an asset for a period lasting longer than two months, in one or more major indices.1 The decline in late 2018 was close, but prices began rising again in late December, and have continued to increase fairly steadily since then. The last few bear markets have lasted 10 to 15 months, on average, with stocks dropping about 30 percent. The last true bear market was from October 2007 to March 2009. During that period, the Dow Jones Industrial Average dropped 54 percent.1 Time to recover from the bottom? Typically about 22 months.2
It’s tough to tell if we’re on the verge of a bear market. Those periods are typically characterized by bad news in some part of the economy, like a recession, a spike in commodity prices, low employment, rising inflation, or asset bubbles. Sometimes they happen when stock prices get overvalued, or when the Federal Reserve raises interest rates.1 Currently, the potential for rising interest rates, Brexit, and trade talks with China are all big factors that are weighing on investor sentiment.2 On the other hand, the overall U.S. economy—largest in the world by far—is still strong. And investors are sitting on increasing amounts of cash. That means they’re cautious instead of showing the kind of excessive risk-taking that leads to a true bear-market plunge.3
However, the point isn’t to try to time the market. Instead, investors should understand that bull and bear markets are inevitable—like weather.
If—or when—a bear market hits, some investors will panic and want to sell. That’s just about the worst decision you can make, as it makes your losses permanent.4 Instead, portfolios should be built for a bear market, in line with an investor’s tolerance for risk and willingness to accept short-term losses. Planning ahead can take some of the emotion of a bear market.5 Assess the risk level of their portfolio and talk through the actual losses they could experience in the worst-case scenario. If they’re not OK with that kind of drop, they should make changes before the downturn hits.1
When everyone else is selling, as often happens in a bear market, you might want to buy. Why? If you and a client truly believe that a given investment is right for that person’s portfolio, it becomes even more attractive when the price drops. Not all clients have this kind of resolve when prices are falling, but those that do—and have a ready war chest of cash—can find good investments at bargain prices.5
Warren Buffett has a famous quote that sums up this philosophy: “Be fearful when others are greedy and greedy when others are fearful.” In 2011, when banks were still suffering from the financial crisis, he invested in companies like Bank of America and Goldman Sachs, generating gains in the billions of dollars as those companies recovered.6
Last, you can help your clients create a bit of a hedge against future declines in the stock market by diversifying and perhaps thinking about alternative investments—assets that don’t correlate directly with traditional investments like stocks and bonds. When the overall market goes down, these may not, giving portfolios some ballast when the markets are plunging. Alternatives investments can be complex and have higher fees, however, they do appear in many types of investment structures.
The bottom line? We may have dodged a bear market in late 2018, but the real thing is coming at some point. By understanding bear markets and helping your clients plan their strategy now, you can make sure they’re ready.
1 Anne Sraders, “What is a Bear Market and What Does It Mean in 2018?” TheStreet.com,Sept. 18, 2018.
2 Kate Rooney, “We Are Now in a Bear Market. Here’s What That Means,” CNBC.com, Dec. 24, 2018.
3 Richard Leong, “Investors’ Cash Buildup Comes at a Cost,” Reuters, Feb. 11, 2019.
4 Ynu Li, “Don’t Panic: Here’s Your Bear Market Survival Guide,” CNBC.com, Dec. 26, 2018.
5 Todd Campbell, “How to Invest in a Bear Market,” Motley Fool, Feb. 10, 2019.
6 Liz Moyer, “Warren Buffett’s Big Bank Score Proves His Saying True Once Again: ‘Be Greedy When Others Are Fearful,” CNBC.com, June 30, 2017.
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