Why this Bear Market Feels so Different, and What Not to Do Now

It’s official – the almost 11 year bull market is over thanks to a couple of “black swans”: COVID-19 and the oil price war.

Quick terminology recap here:

  • Pull-back – a falling of a price from its recent high, typically 5%
  • Correction – typically 10% from recent high
  • Bear Market – 20%+ from recent high

Within a few weeks, we zipped past just a pull-back and correction and are officially in a bear market. Further, a recession is imminent with businesses about to take a hit from “social distancing” and broken supply chains. The US government is trying to get its arms around this threat and is working to eventually restore life back to normal. In the meantime, uncertainty continues. The market hates uncertainty and investors’ portfolios reflect that.

We’ve had pull-backs, corrections, and bear markets before. What’s different this time is the personal impact or the “human effect”. I think all of us have personally felt the coronavirus impact us in the last couple of days with upcoming plans being altered. Many are coping with tough travel decisions with Spring Break around the corner. Handshakes have turned into elbow bumps. Many employees are working from home. And our cherished past time of watching sports gets disrupted with major sports suspending their play. Heck, even Tom Hanks and his wife have tested positive for COVID-19.

Yes, this is certainly different from the Great Recession of 2008 as that didn’t impact personally like this threat has. And because of it, the level of emotion is stronger. And the emotion of fear is dominating right now. And with the help of the media, the fear is building upon itself and, for some, creating panic.

This downdraft has happened so fast – it was exactly one month ago that the stock market was hitting its all-time high – that even if you wanted to, it was almost impossible to react. Stock benchmarks are down over 25% as of this writing. This volatility for most is stressful, unnerving and can be tough to stomach. Fortunately, a balanced portfolio that holds multiple asset classes – not just equities, but fixed income and alternatives – has helped cushion the blow, but not by much given that most investment styles are down.

Emoji Graph

People struggle to separate their emotions from their investment decisions. See the slide above which shows how emotions relate to the different stages of the market. These emotions cause these investors to sell and buy at the worst times as this “recency bias” influences undisciplined investors to chase performance through buying high and selling low.

Now see the slide below which shows what happens when an emotional investor who went to the sidelines and missed the best ten days. The average annual return dropped from 6% to 2.4%. If that investor missed the 30 best days, their return goes negative.

Impact of Market Timing

The moral of the story is you don’t want to try to time the market. You should stay the course and stick with your long-term asset allocation target mix. We have had multiple discussions with our clients about risk. Risk tolerance, risk capacity, and risk perception. And from those discussions, we have identified appropriate long-term asset allocation target mixes. This crazy environment is a test of character to stay with that disciplined strategy and not give in to fear. It sounds hard to do, particularly, in scary times like now, but disciplined investing has ALWAYS paid off. The market inevitably always bounces off its lows to eventual new highs.

We aren’t calling this the bottom, by no means. We don’t know exactly what tomorrow brings. No one has a crystal ball. The market could trade lower, but if you have faith in our country pulling through this pandemic like it has in the past and understand this threat will be beaten, then remain disciplined and fully invested in your long-term asset allocation. We understand that everyone is wired differently and based on your current perception of the risk today, that may be hard to do. If so, please contact us so we can discuss further.

 

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DWM 4Q18 & YEAR-END MARKET COMMENTARY

Fantasy Football and portfolio management may be more similar than one would think. Over the past weekend, I drafted a playoff fantasy football team which I’m hoping will amass more points than the other five “owners” in my league. Fantasy football drafting for both the regular season and playoffs is similar in that you want to take the NFL players that get the most touchdowns and the best stats in turn for rewarding you with higher points. The team with the most collective points wins! However, playoff fantasy drafting is much different than a regular season fantasy draft, with the key difference being one doesn’t know how many games that a player will actually play! Patrick Mahommes may be the best player available per game on paper; but if his KC Chiefs lose in their first game, a middle-of-the-road player like Julian Edelman from the Patriots who is expected to play multiple games, can be superior. Thus, the key is trying to pick not only the best available player, but also the one who will play the most games.

It’s sort of like investing, where picking NFL players and their teams become synonymous with picking companies. You want a collective bunch of players/securities that outperform others which ultimately leads to higher values. I looked at this draft pool of players like I would constructing a portfolio: diversifying my picks by player positions and teams.

Some of the other owners didn’t follow this disciplined approach, instead opting at throwing all of their marbles into the fate of one team and hoping it would lead them to the Fantasy Football Holy Land. And just like investing all or the majority of your dollars into one stock, this type of “coaching” can lead to utmost failure. Case in point: one owner loaded up on one team, taking several players on the Houston Texans. Ouch. (If you’re an NFL fan, you know that the Texans were squashed by the Colts and are out of the playoffs, just like this “owner” is now out of contention in our Fantasy League!) The morale of this story is: there is no silver bullet in football or investing; stay disciplined and diversified and reap the rewards over the long term.

And now onto the year-end market commentary…

Unfortunately, there were not many good draft picks this year. In fact, as stated in one of our previous blogs, around 90% of asset styles were in the red this year. And I don’t mean the Red Zone! Let’s see how the major asset classes fared in 4q18 and calendar year 2018:

Equities: Stocks were driving down the field, reaching record highs right before the 4th quarter began and then…well, let’s just say: “FUMBLE!” with the MSCI AC World Index & the S&P500 both dropping over 13%! This was the steepest annual decline for stocks since the financial crisis. Yes, investors were heavily penalized in 4Q18 for several infractions, the biggest being:

  • The slowing of economic growth
  • The ongoing withdrawal of monetary policy accommodation, i.e. the Fed raising rates and until recently, signaling more raises to come
  • Trade tensions continuing to escalate
  • The uncertainty of a prolonged US Government shut-down
  • Geopolitical risk

None of these risks above justify the severe market sell-off, which brought the MSCI AC World Index to a -10.2% return for 2018. This is in stark contrast to 2017, when it was up 24.0%! “Turnover!” Frankly, the stock market probably overdid it on the upside then and now has overdone it to the downside.

Fixed Income: The Barclays US Aggregate Bond Index & the Barclays Global Aggregate Bond Index “advanced the ball” in the fourth quarter, up 1.6% and 1.2%, respectively. Still, it wasn’t enough to produce any “first downs” with the US Agg essentially flat and the Barclays Global down 1.2% on the year. Bad play: In December, the Fed raised rates another quarter-point and indicated they may do more. Good play: within the last week, they may have completed the equivalent of a “Hail Mary” by signaling a much more dovish stance – it certainly made the stock market happy, now up 7 out of the last 9 days at the time of this writing.

Alternatives:  Like an ordinary offense playing against the mighty Chicago Bears D, alts were “sacked” in the fourth quarter as evidenced by the Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, falling 4.0% for the quarter and finishing the year down 5.1%. This is the worst showing ever for this alternative benchmark. Frankly, we are shocked with this draw-down, chalking it up to 2018 going down as the year where there was no place to hide. Gold*, Managed Futures**, and Merger Arbitrage*** proved to be good diversifiers in 4q18, up 7.5%, 3.6%, 2.4%, respectively; but not many “W’s” (aka “wins”) for the year in alts or any asset class for that matter.

Put it all together and a balanced investor is looking at negative single-digit percentage losses on the year. Yes, 2018, in particular the fourth quarter, was a brutal one for investors. It was like we were in the Red Zone about to score an exhilarating touchdown, only for a “Pick 6” to happen. (Pick 6 is when the football is intercepted and returned into the opposing end zone.) What we learned is that “L’s” (aka “losses”) or corrections can still happen. Going into this year, many had forgotten that markets actually can and do go down. Further, markets can be volatile, down big one day, and up big the next. So what is one to do now, besides putting the rally caps on?

The answer is: essentially nothing. Be disciplined and stay the course. Or, if your asset allocation mix has fallen far out-of-line of your long-term asset allocation target mix, you should rebalance back to target buying in relatively cheap areas and selling in relatively expensive areas. Or, if you happen to have come into cash recently, by all means put it to work into the stock market. This may not be the absolute bottom, but it sure appears to be a nice entry point after an almost 20% decline from top to bottom for most stock indices. From a valuation standpoint, equities haven’t looked this attractive in years, with valuations both here in the US and around the globe below the 25-year average.

And speaking of football, it’s easy to be a back-seat quarterback and say, “maybe we should’ve done something differently” before this latest correction. But we need to remember that empirical studies show that trying to time the market does NOT work. You have to make not just one good decision, but two: when to get out and when to get back in. By pulling an audible and being out of the market for just a few days, one can miss the best of all days as evidenced by the day after Christmas when the Dow Jones went up over 1000 points. In conclusion, if you can take the emotion out of it and stay fully invested through the ups and downs; at the end of your football career, you give yourself the best chance to make it to the Super Bowl.

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

 

*represented by the iShares Gold Trust

**represented by the Credit Suisse Managed Futures Strategy Fund

***represented by the Vivaldi Merger Arbitrage Fund