Bearing the Bear Market

Spencer Kelly, CFP®

Spencer Kelly, CFP®

Co-founder, Managing Partner & Head of Advisory Services

Markets bottom when we least expect it – oftentimes, well before the actual news or economy changes course. Trying to time the bottom can be a fool’s errand as markets are forward looking and predicative in nature. Recently, I read an article by Jason Zweig, who writes “The Intelligent Investor” for the Wall Street Journal. I thought he summarized what it feels like to be an investor in a bear market well, so I wanted to pass his words along to you [edited to fit our newsletter]:

Part of what makes bear markets so unbearable is that nobody—and I mean nobody—knows when or how they will end.

That doesn’t stop everyone on Wall Street from flogging measures, hunches and folklore purporting to foretell when stocks will finally stop falling.

However, intelligent investors don’t bother trying to predict the unpredictable; they focus on controlling the controllable. That’s the psychological key to surviving this—and any—bear market, no matter how long it lasts.

To see clearly why it’s so important to get your priorities straight, let’s look quickly at three beliefs about when bear markets end.

Supposedly, bear markets do not end until:

  1. Individual investors throw in the towel,
  2. Fear hits new heights or
  3. Stocks finally get cheap again

Taking each in turn, here is why they are myths.

1. Retail investors have to capitulate.

Professionals love to argue that bear markets hit bottom when individual investors give up on stocks in a crescendo or “capitulation” of panic selling.

Only trouble is, that isn’t what happened in 1932, 1974, 1982 or 2002, among many examples. Bear markets sometimes end in a selling frenzy, but they often end in an indifferent stupor.

2. Fear has to spike.

Many professionals contend that the CBOE Volatility Index, or VIX, is “too low” right now.

The VIX, commonly called Wall Street’s “fear gauge,” spiked to then-record highs in October 2008, during the global financial crisis—but stocks still fell more than 19% before the bear market finally ended in March 2009.

“When markets are trying to reprice their expectations of the future, they only nibble away at that truth,” says Mr. Colas. No single indicator like the VIX can capture the moment when those expectations are about to shift.

3. Stocks have to get a lot cheaper.

Many investors believe bear markets end only after formerly overvalued stocks finally become bargains again. It just isn’t so.

In March 2009, in the pit of the global financial crisis, stocks traded at more than 13 times their longer-term earnings, adjusted for inflation, according to data from Yale University finance professor Robert Shiller. That was only about 20% cheaper than the average all the way back to 1881.

Although stocks didn’t seem like a statistical bargain at the time, they went on to gain roughly 15% annually over the next decade. All this shows the folly of trying to figure out when stocks have hit bottom.

So, you should distinguish what you can control from what you can’t. Instead of wasting your time trying to read the market’s tea leaves, take charge of the risks you run, the taxes you incur and your investing time horizon.

Being a buy-and-hold investor doesn’t obligate you to use a death grip. If some of your stocks or funds have performed abysmally in this downturn, you can sell them, [find better companies] and reap significant benefits.

Dumping your most dismal investments should enable you to book a loss. You typically can use this to offset capital-gains taxes on investments you sell at a profit, either this year or in later years. [Regatta has been doing this where applicable over the past few months]. You can also deduct up to $3,000 of those losses each year against your ordinary income, carrying any losses in excess of $3,000 forward to use as offsets against your taxable income in future years.

Another decisive step investors can take in a bear market is to consider converting a traditional individual retirement account into a Roth IRA [again, we/Regatta have been looking for these opportunities where applicable].

Normally, the deterrent to converting a traditional IRA to a Roth is that the conversion is taxable at your ordinary-income rate. Now that so many investments are down 10% to 20% or more, however, the amount on which you will be taxed is significantly lower. So, forget about squinting into a crystal ball to try figuring out when the bear market will end. Instead, control what you can.”

Here at Regatta, we have been proactively building your portfolios to be ready for the inevitable storms. And here we are, in the eye of the storm, with the stock market having its worst start to a year in 50 years and the bond market having its worst start to a year in 40 years. This does not feel good. But I can assure you, we have done the planning, had the conversations and constructed the portfolios to weather this storm. To Jason’s point above, we need to focus on what we can control and avoid making permanent mistakes to well thought-out, long-term plans. This storm will pass and will be by your side along the way to navigate every twist and turn. The planning we have done for you does not mean we get to avoid the short-term pain of this downturn, but it does mean you can have the confidence to know that your long-term plans are still on track.

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