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Adrian Mastracci, president of KCM Wealth Management, says “There is no one right answer that fits all portfolios. The options of dealing with a potential bear market can also be personalized." |
Vancouver, BC (May 30, 2006): Once upon a time, back in the days of science classes, we learned that for every action there was a reaction.
The markets are similar. As an example, for every buyer there is a seller. For every bear market there has been a bull market, eventually.
Ralph Waldo Emerson, American essayist, poet, and philosopher once said, “I dip my pen in the blackest ink, because I'm not afraid of falling into my inkpot”.
Adrian Mastracci, Chief Investment Officer with “fee-only” KCM Wealth Management in Vancouver, comments, “I dip my pen, not in the blackest ink, but in the reddest ink. The big picture on bear markets since the year 1900. Financial history provides pointers on what investors have endured.”
This musing on bears past was prompted by recent publications making the case that US economic data is heading into slowdown territory ahead. A severe slowdown could trigger another bear market.
Are these publications right? I don’t know, but one day they will be. So, it’s valuable to put this topic in personal perspective with the financial goals we all seek.
Let’s look back at financial history over a relatively long period. I’ve chosen the years 1900 to 2006, from which to extract some bear market facts.
1. Bears defined
Bear markets are defined in many ways. One is a 15%, or more, price decline of a widely followed stock index. Such as the Dow Jones, S&P 500, NASDAQ or the TSX Composite.
The main suspects known to cause bear markets include the economic recessions, high inflation or high unemployment. Such periods are also accompanied by much investor pessimism.
Bear and bull markets are part of a cycle of anticipation. Investors generally start to lose confidence if they expect corporate earnings to decline. Thus, creating the atmosphere for a possible bear market.
Conversely, investors begin to regain confidence if expectations of better earnings lie ahead. Thus, creating the roadway for a potential bull market.
Investors may wonder how bear and bull markets got their names. Evidently, bears strike things down with their paws, while bulls throw things up with their horns. At least, it makes for a good story.
2. Back to the future
By my count, investors have weathered 23 bear markets since the year 1900. The Dow Jones price declines ranged from about -16% in 1998 to -89% in the1929-1932 period.
Hence, we’ve had a bear market, on average, nearly every 5 years. Typically lasting from 3 months to 3 years. We all remember the last bear that ended in October 2002.
The most famous US bear market was the crash of 1929 that ushered in the Great Depression. The quickest was the crash of 1987 where the Dow Jones plummeted over -22% in one day alone.
The Dow Jones index is much higher today than in 1900, when it was composed of only 12 stocks. Hence, over time, bull markets have typically risen more than the bear market declines.
Bear and bull markets are part of the investing experience. The fact that they happen is no surprise. It is doubtful that investors can escape the grip of a bear market during their investing life.
My solution is simple. Learn to accept them.
3. Bearish options
In a previous newsletter, I outlined three key lessons of investing to be long-term thinking, broad portfolio diversification and trying not to incur a large loss. Investors with a well thought out personal asset mix are better equipped to deal with the fearful markets.
These days I’m reminded of the “Caution, slippery when wet” sign. The same good judgement applies to the markets. Particularly, when bear talk is making the investment rounds again.
There is no one right answer that fits all portfolios. The options of dealing with a potential bear market can also be personalized. Something like this:
- If the market risks still feel comfortable, stay with the chosen asset mix.
- If the suitable mix of assets is not yet in place, have it constructed.
- If the risks seem higher than the personal tolerance, reduce exposure to equities.
- If capital preservation is uppermost, consider a healthy dose of fixed income investing.
- If cash is the primary asset now owned, allocate it over a period of time, say 1 to 2 years.
Investors can achieve a fixed income return just over 4%. That is for quality maturities ranging from 1 to 3 years. It’s a normal and understandable position to take for the risk averse.
Fixed income portfolios represent a base return for investors who cannot stand bear market risks. No drubbing if equities decline in value. No upside potential if equities rise further.
Some capital gains, losses and exit costs may have to be considered in selling current portfolio holdings before going to the sidelines. Perhaps, costs of getting back in when the time comes.
We will sustain yet another bear market someday. I just don’t have the starting and ending dates for the next one.
As always, I welcome your questions and comments.
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