First let us review what is a “bear market” and what are the implications. Simply put, it is a decline of 20% or more from a previous peak. Today the S&P 500 briefly flirted with bear market territory, at one point reaching a 20% decline from the all-time high, though it ended the day flat and is now “only” down about 18% from its peak. The NASDAQ (both 100 and the composite index, it drives me crazy when people don’t specify which one they are talking about) is currently in a bear market, as both (coincidentally) are down about 27% from the recent all-time highs in late 2021.
The 20% bear market threshold is an arbitrary definition that has been used for many years. I don’t know where that started; it could just as easily be set at 15% or 23% or some other number. The implication is the deeper the decline, the longer the time it takes to get back to the previous peak. When we look at history, the length of the current decline is about average for the low point of a correction (another arbitrary definition, a decline of at least 10% but less than 20% from a high point). Bear market recoveries typically (but not always) take longer, which is why people focus on them so much.
The last few market declines have been quicker and sharper, as have the recoveries. The last bear market we saw was back in March 2020, that decline was quick and painful, but only lasted a little over a month, and the market was back to new highs in less than six months. It is impossible to time avoiding these declines successfully, while participating in the recoveries.
“But this time it’s different.”
Maybe, maybe not. There have been many declines over the years, it is just a part of investing. There’s always something to worry about in the stock market. Currently we have the war in Ukraine along with currently high inflation readings in the U.S. and the persistent COVID-19 pandemic worldwide.
The key is to remain in position for the eventual recovery by avoiding dramatic changes to your mix of assets. When will the current decline end? No one knows for sure.
Interestingly, about half of the decline this year in the S&P 500 is due to only eight stocks (there is a good article about this today in the Wall Street Journal, if you have access). These are the large technology and communication services stocks, household names, that displayed narrow leadership of the overall market over the past few years. Any investor with a diversified portfolio has some exposure to these stocks, through broad-based ETFs or mutual funds. The good news for our clients is that they generally have less exposure than the overall market to five of these names, and we have no direct exposure to the other three (just a trace coming in through the funds). Our client portfolios include small-, mid-sized and international companies so are better diversified than the S&P 500, which consists of large U.S. companies.
This is another term we hear a lot of talk about currently. It’s another form of jargon (our industry has no shortage of that, so we try and break it down to communicate in ways that people understand). Let’s just say “big moves” instead. Big daily moves tend to cluster, both up and down. This is distressing to investors, particularly those in retirement whose earned income has stopped, and even more so for those who are newly retired and still getting used to the concept of not having a paycheck coming in after so many years of working.
It takes a daily move of about 2.5% to make the list of the top 200 moves over the last 50 years. We’ve had 10 such moves so far this year, including four in May and four in April. By comparison, for all of 2021, we only had one such move. And this year there are likely to be more such moves, both up and down, given that this is a mid-term election year. It is important to recognize this and be mentally prepared. Dealing with these fluctuations is stressful at the time but is the price we pay to end up with more money in the long run.
Why is the market down?
This is another question that no one knows the answer for sure. The common theme is uncertainty of some sort. Current examples are uncertainty about how long the war in Ukraine will last, uncertainty about how long inflation will persist at elevated levels and uncertainty about whether we have another recession in the US. These are interrelated to some extent. At some point, these uncertainties will be resolved and new ones will take their places.
What about inflation, and will there be a recession?
We’ve discussed both of these topics in recent webcasts. We all know inflation is currently elevated, just go to the gas station or the grocery store. We believe it is likely to remain higher than average this year and next but will begin to moderate as supply chain pressures eventually ease and there is an eventual resolution to the war in Ukraine. We are monitoring the changes in the Consumer Price Index as well as data on global supply chain pressure. Gasoline prices will likely remain elevated for a while, they are quick to go up and slower to come down.
The main investment implication of higher inflation is that you want to maintain a significant allocation to stocks with rising earnings and rising dividends, resulting in rising portfolio income over time. This will help mitigate or offset inflation.
We believe it would be difficult to have a recession with the economy at full employment and many more job openings than workers. One silver lining to the COVID pandemic is that labor is now much more mobile that it was before, due to a huge increase in remote and hybrid working. This allows for better matching of workers with job openings, since geography has become less of a factor.
Another factor we look at with regard to both inflation and recession risk is the “slope of the yield curve” (more jargon). This just means are long-term interest rates higher than short-term interest rates.
Just a few months ago there was talk of a possible impending recession, because the 2-Year Treasury Note yield briefly moved above the level of the 10-Year Treasury Note yield. That talk has settled down now that those yields have flattened out.
We prefer to look at the difference between the 3-month Treasury Bill and the 10-Year Treasury Note. That spread is currently +1.81%, which is healthy. And with a 10-Year Treasury yield at 2.82%, we can see that the bond market is not forecasting runaway inflation.
Don’t just do something, stand there.
It’s the hardest thing to do psychologically. As humans our brains are wired to do exactly the wrong thing at the wrong time in the stock market. It’s like driving on an icy road with a ditch on either side, fear on the right and greed on the left. The car may swerve around a bit (market conditions), but it is important to keep it pointed forward and on the road.
The most important thing you can do is to stick to your financial plan and avoid dramatic changes to your mix of assets. And realize, whether you see trade confirmations on your accounts or not, there is always a lot going on behind the scenes with regard to your portfolio and investments in terms of research and management. Our Director of Investment Management, Sarah DerGarabedian, did a nice presentation on this in our Q4 2021 webcast. I like to call her the “voice of reason” in her appearances on CNBC, since she focuses on long-term success rather than what’s up or down today.
Don’t reach for yield or move into more speculative assets like cryptocurrencies with any significant portion of your assets. Many cryptocurrencies are down 80% or more over the last year. Even the dominant ones like Bitcoin and Ethereum have not proven to be good hedges against inflation or market declines recently, as both of these are down significantly this year.
Don’t just stand there, do something.
Focus on what you can control. Review your current level of cash to ensure you have enough of an emergency reserve (generally 3-12 months’ worth of after-tax living expenses, depending on your personal situation and comfort level). After that, get your excess cash invested in some way. Cash yields work the opposite of gasoline prices (that is they are quick to go down and slow to come up). So, drive less, consolidate trips and get your cash invested.
- Add your excess cash to your Parsec portfolio, where it will be automatically invested at your selected asset allocation. Whether all at once (statistically better), or over time using a systematic investment policy (”or SIP”), our standard for this being 5 months.
- Check out Series I savings bonds for a portion of your excess cash. Limited to $10,000 per tax payer per year, money is tied up for 1 year, bonds issued from now until 10/31 will pay interest at an annual rate of 9.62% for the next 6 months. The rate will then reset for the following 6 months based on the Consumer Price Index as of 9/30. This is one way you can benefit from currently high inflation readings. More details are available in our last webcast and we also have a blog on the subject. All of this can be done online at www.TreasuryDirect.gov.
- Get your excess cash out of money market and savings accounts paying 0.10% or so and into short-term Treasury Bills at 1% or so. This also can be done online at www.TreasuryDirect.gov.
Focus on what you can control, ignore what you can’t and stick with the plan. This too shall pass, we will get through these conditions together, as we always have in the past. It is a fascinating time in financial markets and the last two years of exceptional returns have demonstrated market resilience in the face of adversity. We all need to be resilient too, as well as disciplined. Thank you for your trust and confidence in Parsec.