Dear Reader,
In early March, I wrote about the stock market declines of the first 60 days of 2022.
In mid-May, I wrote about the further declines experienced in what (at the time) was a terrible start to the first half of the year.
You can access these articles at https://www.adamschacter.com/blog-1 which will provide context to the information below.
This week, the S&P 500 (the stock market index tracking the performance of 500 large companies listed on stock exchanges in the United States) officially entered “Bear Market” territory. Providing you with some information on what this means, why this is occurring, and what to do about it is likely timely at this point.
One thing you can do before you read further: take a deep breath. These downturns are quite normal and what you do from here can make or break your future wealth. It’s very natural to feel like your retirement, your future big purchase, your kids’ education, and your legacy are all under threat.
If anxiety about your financial future is reaching a boiling point, this is the time to reach out to your financial advisor to schedule some time to review the plan in place and to ensure there is a strategy to ensure you not only withstand, but also potentially come out of this better on the other side. Don’t panic, this too shall pass.
If you don’t have an advisor, try your best to put your emotions in the back seat and let logic and sound rational decision-making steer the ship. Investing is best performed without excitement or panic – even keel.
What is a “Bear Market”
It’s crucial to first note that any asset that goes up or down in value is simply a function of someone else’s (in this case, the entire investing public) willingness to spend more or less for that asset (decreases in asset values occur when there are more sellers than buyers due to more overall pessimism than optimism).
This holds true for every asset (a public stock, a grocery orange, a used car, a property) and no matter the reason for the optimism or pessimism (cash flows, location, competitive industry advantages, interest rate increases, inflation, geopolitical turmoil, global pandemics). An asset that is available for purchase and sale is valued as a function of what people are willing to pay for it.
There is a great article from the CBC titled: “When stocks, houses and crypto fall, where does all that money go?” which outlines this concept beautifully that you can access here: https://www.cbc.ca/news/business/markets-crypto-assets-column-don-pittis-1.6486826.
A bear market is defined by a market decline of 20% or more from its peak over at least a two-month period. Retail investors typically don’t like bear markets because the value of their investable wealth goes down and this investable wealth represents tangible items such as retirement income, new homes, education costs, legacy, etc.
All graphs below are source: Google
The S&P 500 Index is down -23.46% YTD (year-to-date: since January 1st 2022)
For those opportunistic investors, price declines offer an opportunity to buy the exact same things at lower valuations (on sale).
Imagine for a moment that you purchased a non-perishable from the grocery store each week (let’s say your favorite can of tuna). Like clockwork each week, you buy the same can of tuna for $1.00. This week however, when you get to the grocery store, you see that the market value of this same can of tuna has plummeted 30% (down to $0.70). Do you panic? Is there something now wrong with the tuna? These are the same exact cans that you saw in the grocery store last week. In fact you ate one yesterday! Do you race back home, pull out all the tuna from your pantry and sell them to anyone willing to buy them as fast as you can?
Or… do you buy more of it and “stock” up (pun intended) before the price invariably goes back up to $1.00.
You have to admit, it is kind of funny that in our industry, when prices are marked up, the customers seemingly can’t buy enough fast enough (real estate, bitcoin, etc). And when prices go on sale, panic seems to set in and everyone sells their inventory.
It’s still the same tuna can.
Below is the same graph above zoomed out and dated back to August 1982. This graph includes declines such as “Black Monday”, the Russian Rouble Crisis, the “Tech-Wreck” of the new millenium, the Global Financial Crisis, The Covid-19 Pandemic, and this most recent pullback still in process.
Google and the Google logo are registered trademarks of Google LLC. Used with permission.
In hindsight, these look like the times to have stocked up on tuna.
Let’s examine bear markets in more detail. We’ll use the S&P 500 as our reference point for most of this since it is the most commonly used index in the world and is used as a barometer for the overall health of the stock market in general.
How low can bear markets go? And for how long?
The graph below shows the previous 11 bear markets of the S&P 500 since 1956, the length of time of each bear market (in months), the amount of decline (in percentage), and the amount of time it took for the market to recover (in months).
A few things to extract from from this graph:
The first thing that stands out to me is that it’s not a question of “if” a recovery happens, but merely a question of “when”. It’s hard to imagine all 500 of the biggest companies in the USA all going bankrupt at the same time… The “Armageddon” scenario is unfortunately not something we can plan for or address in this article.
The second thing that stands out to me is that the deepest decline was -56.8% in October 2007 (essentially bend but not break) which would have been terrifying to anyone close to or in retirement.
Another standout is the length of each recovery, most of which seem to bounce back within a year or two, except for 3 very lengthy recoveries highlighted by the January 1973 bear market, which took the absolute longest to recover – a whopping 69 months (5 years and 9 months). Now some of you may be thinking: “I don’t have 6 years to wait!” (more on that below).
My last thought on this graph is that these numbers presented are attributed to what would happen if you did absolutely nothing and did not buy or sell through the time periods in question.
What if you had sold your investments during these bear market time periods?
What if you had bought more of your investments during these bear market time periods?
The most recent Bear Market
On March 12th, 2020, the markets entered a bear market for the first time in 11 years, falling from all-time highs amid the economic impacts of the COVID-19 pandemic.
If we look at what transpired here at home at the TSX Composite Index (the benchmark Canadian index, representing roughly 70% of the total market capitalization on the Toronto Stock Exchange), the peak-to-trough (highest to lowest) points of 2020 included a decline of -39.3% (!).
Are big declines like these normal?
Volatility in the markets is quite typical, and if we look back at every calendar year of the TSX Composite Index’s peak-trough decline since 1980, you can see that there are some significant market swings within each year.
As mentioned above, the TSX had a peak-to-trough decline of -39.3% as recently as 2020. This is of course overshadowed by the largest peak-to-trough decline through this time frame, which occurred in 2008 and was -53.0% (!).
For the most part, these intra year declines seem to occur quite regularly and average out to be -16.4% each year.
What also stands out to me in this graph is that despite the average intra-year decline of -16.4%, the number of calendar years that the market finished the year ahead of where it started vastly out-paced the negative ones (30 out of the past 42).
The bigger and sharper the decline, the scarier the perceived threat to your financial well-being. The graphs show that keeping a cool head and keeping with the strategy you have in place (or at the very least, doing absolutely nothing) prevails.
Recovering From a Bear Market
Bull markets (the opposite of a bear market) are defined by a market increase of 20% or more from its low over at least a two-month period.
Side note: most do not panic during Bull Markets, nor wonder if there is anything wrong with the state of the markets.
While bull markets often last for years, a significant portion of the gains typically accrue during the early months of a stock market rally after a bear market (https://www.thebalance.com/what-is-a-stock-market-rally-5208687).
For example, after the S&P 500 bottomed at 777 on Oct. 9, 2002, following a 2.5-year bear market, the stock index then gained 15% over the following month and a total of 34% over the following year (https://www.yardeni.com/pub/sp500corrbeartables.pdf).
The S&P 500 bottomed at 676.5 on March 9, 2009, after declining 57%. From there, it began a remarkable ascent, roughly doubling in the following 48 months.
For those investors who abandon their current strategy during a bear market for fear that the strategy in place is not working and that things are going to get worse, you may want to reconsider such action since properly timing the beginning of a new bull market can be challenging and costly.
For those investors who flee to cash during bear markets, keep in mind the potential costs of missing the early stages of a market recovery, which historically have provided the largest percentage of returns per time invested. Of course, you can get back in once the market has recovered and the Bull market is underway, but missing out on just those early days of the recovery can be quite costly:
This graph shows the amount you would make if you remained invested $100K for 10 years ending December 31st, 2021.
The first bar shows how much you would have in total if you closed your eyes and remained fully invested ($239,816). The 2nd graph shows how much you would have in total if you just missed the best 10 days in the 10 year timeframe ($147,184) and so on.
Timing the market (pulling money out before it goes down and putting it back in before it recovers) has historically been much worse for investors than remaining invested.
The best thing to do today may be nothing at all.
Investing During a Bear Market
If you hold cash, cash equivalents, or conservative fixed-income, you may want to consider buying the opportunities during a bear market, as value ratios create more favorable entry points for purchase. When investors are more confident, the market typically increases, pushing stock valuations higher. Professional investors love bear markets because stock prices are considered to be "on sale."
How do pension funds and endowments funds handle bear markets
Pension funds and endowment funds have an asset allocation that is different from retail investors. They have a long-term time horizon much like investors saving and decumulating over the long-term. When you have Billions of dollars and are accountable to pensioners and endowment stakeholders, the type of investment solutions available widens.
Yes, pension funds and endowment funds hold public stocks and bonds like everyone else, but they also have the ability to hold real estate, private equity, infrastructure, hedge funds, private debt, mortgages, and more. This helps diversify a portfolio by breaking away from the correlation of the public markets.
As luck should have it, my partnership with Mandeville allows me to participate in these same investment strategies, so if you are a client of mine reading this, your portfolio’s decline has likely been tempered by the amount invested in these asset classes.
If you are not a client at this time, please feel to reach. I welcome the opportunity to share the mathematical advantages these asset classes offer.
What to do from here
Investing has been quite the party over the past 14 years, but it can be quite nerve-racking when things don’t go as expected in the short-term. Amateur investors have been able to buy companies and assets they “like” (for whatever the reason), and have made gains exceeding what is considered to be normal for the length of time in question.
If you want to reap the benefits of long-term wealth creation, then you need to be able to stomach the wild ride that is the public stock market. Holding non-stock investments help reduce the daily and monthly ups and downs of the market and can provide the additional diversification needed in case certain assets don’t recover.
Even if you are a retiree, you should still be invested in the markets due to still having a long time-horizon (until life expectancy). If you're in this category,
Here is a recap of the last article from May 12th 2022, which you can access here: https://www.adamschacter.com/blog-1
Here's what I know:
Markets trend upward over time.
Market declines are normal.
Markets always reach a new high in time.
Here are some things you can do today:
1. Check in on your goals and objectives
Are you still on track?
2. Own quality
Is the core of your portfolio composed of a few quality business domiciled in long-term growth industries, operated by management with skin in the game (stake ownership)?
3. Hold some assets that are not correlated to public markets:
This includes real estate, infrastructure, private equity, mortgages, private credit, direct investment, resources, real assets, and more.
Note: this is how Billion Dollar portfolios are constructed, like the Canada Pension Plan, Ontario Teacher’s Pension Plan, Harvard Endowment Fund, and ultra-wealthy individuals'.
If you don’t have access to these types of assets for your portfolio, please reach out. Where appropriate, there is a mathematical advantage to owning these kinds of investment assets.
4. Diversify
Holding varying kinds of assets in varying parts of the world in different structures with different managerial styles with varying liquidities in different sectors should help to ensure that no single “bet” is too large and too risky to your portfolio.
5. Strategically rebalance
If you own different kinds of assets (see Diversify above), and you still believe in the assets that have temporarily gone down in value, then you can sell/trim some of the positions that have increased or held steady (or have not fallen by as much) and use the proceeds to increase your positions in those that have gone down the most.
If you undertake this strategy, it is recommended to use a defined framework which removes intuition, insight, emotion, and timing.
If you don’t have a strategy like this in place, please reach out and we can show you how to implement one.
6. Stick to your framework
Abandoning a strategy seems to always comes at the worst possible time. If you have a proven and effective framework, stick to it.
What if you are retired and don't have the time to recover
Even if you are a retiree, you should still be invested in the markets due to your still having a long time-horizon (until life expectancy). If you're in this category of investor, your appetite for risk is likely lower, and you should be invested accordingly. If you are continually drawing income from your portfolio (like a RRIF), then a cash-wedge strategy is likely appropriate for you, eliminating the need to sell an asset when it has temporarily declined, while still ensuring that you are a long-term investor reaping the returns needed to avoid outliving your retirement assets.
Please reach out if you would like to know more about this cash-wedge strategy for income portfolios.
I sincerely hope this helps ease your nerves and calms your mind if you're feeling useasy.
If you would like to review the strategy we have in place for you for times like these, or if you want a second opinion on your current strategy, please reach out. We are available and would be happy to discuss/review.
The take-home here is to ensure you have a framework for long-term investing, and to ensure your emotions (excitement when markets are up, fear when markets are down) don’t cloud your judgment in sticking to that framework.
If you have any questions about your financial plan, would like our opinion on what this current financial landscape means for long-term investors, or would like a refresh on the framework we have in place for times like these, please never hesitate to reach out.
We are available and accessible to you any time through email, phone, and video.
Be well and be safe,
Adam