Some Key Concepts Useful in Navigating Today’s Markets

Since stocks breached -20% on June 13  from their prior high, crossing the popular threshold for a bear market, a constant drumbeat of headlines has warned of worse to come. In these trying times, the urge to do something may seem overwhelming—but doing something can easily backfire. In that vein, here are some dos and don’ts we think can help you in difficult times like the present.

We know bear markets are hard—and frightening. Enduring one is far from ideal. When a bear market comes amid a series of seemingly relentless negative news stories, cutting equity exposure may look like the sensible and prudent thing to do. Take your losses and live to fight another day. In our experience, though, that isn’t wise, as selling crystalizes declines into losses and increases the chances you miss the recovery—the chance to recoup those declines. Hence, our first recommendation.

Don’t panic. When all seems lost, that is the best time to stay calm and collect yourself. First, assess your situation. Ask: Is my portfolio’s asset allocation (the mix of stocks, bonds, cash and other securities) designed with bear markets in mind? Meaning, are the expected long-term returns it is based on inclusive of bear markets? If so, it should meet your longer-range financial goals even with occasional downturns—including historically bad ones. Mitigating bear markets’ drops may be nice, even beneficial, but it isn’t necessary to reach your goals. The ride may be bumpy, but participating in a bear market shouldn’t derail your long-term goals as long as you also participate in bull markets.

Do look forward. Nobody knows exactly when the downdraft will end. Inflection points are impossible to identify until well after the fact. However, it will end. Historically, bull markets have always followed bear markets, the recoveries are usually strong, and stocks typically continue on to even higher highs than before the bear market. The key is to participate in the upswings when they come. Reacting to past downside risks locking in the decline—which then necessitates timing a reentry very well. That is tough to do, considering buying when markets are lower requires a) them to fall further and b) you to have the gumption to buy when things look even worse than now. Market recoveries are typically very strong and start when very, very few expect them to. Try to look to that now.

Don’t chase heat. Besides going to cash, the other bear-market temptation is to chase the downturn’s winners. In this bear market, Energy is the clear standout. Since the MSCI World’s high on January 4, Energy is up 18.3% versus the benchmark’s -22.8%.^[i] But through June 8, Energy had risen 45.9%, benefiting from many of the worries that have plagued stocks generally this year—like persistently high oil prices.^[ii] Since then, though, it has declined -19.0%—almost its own sector “bear market.”^[iii] We think this, too, is sentiment-driven, reflecting fears of a recession destroying demand. While a recession is possible, despite sentiment otherwise, we don’t think it is likely. But if that changes and one does arrive, Energy stocks would likely do quite poorly due to their cyclical nature, alongside value stocks that normally underperform in prolonged fundamentally driven bear markets due to their economic sensitivity and reliance on credit, which tends to dry up in a recession.

Do maintain liquidity. We would also suggest avoiding illiquid assets—e.g., private equity and collectibles. We think such investments can be especially dangerous because although they might appear to be doing well or holding up, that may be illusory. Because they don’t trade often, their prices may be stale—not reflecting current market conditions—or be subject to dodgy pricing generally, using alternative methods to gauge their worth that you would want to read the fine print on. There is also high risk of encountering scams in the world of collectibles, particularly in the age of digital/securitized collectibles.

Do steer clear of flashy sales pitches. In a similar vein, products and services that prey on bearishness abound. Low-volatility or inverse (and leveraged) ETFs may top performance leaderboards this year—and are advertised that way—but that is just another form of heat chasing. Annuities or options strategies may also beckon—but these can be quite complicated and, we find, often aren’t worth the supposed bells and whistles they offer. Problems range from expense to low, CD-like returns, even when the names suggest otherwise. Note, too, that annuities are very long-term decisions that can be quite illiquid and costly to exit. Emotions are the enemy here. Always remember this general rule: Products touting capital preservation and growth are a myth—the two goals can’t coexist. The former requires assets that don’t move in price; the latter the opposite. It is an irreconcilable divide.

Don’t dive into dividends. To be clear, we have nothing against dividends, but chasing stocks for their dividend yields alone is far from a sure-fire strategy through rocky markets. Remember, dividends are a return of capital, not a return on them. When paid, the stock price drops by the dividend’s amount. People often see the dividend payment as a cushion, but in doing so they ignore that dividend stocks are also subject to price movement. Reinvested dividends are but one part of total return, and dividend stocks aren’t always outperformers during a bear market. Moreover, dividends can get cut—and often are at the worst possible time, deep into a downturn. It can also lead to overconcentration in sectors and industries, negatively impacting your diversification.

Do remember bear market rallies are normal and the low will be clear only in hindsight. Big downswings frequently come with big upswings in a bear market. Getting caught up in relief on a rally is as much an error as despairing during a renewed drop. As always, past price changes—down or up—don’t say anything about future ones, and short-term moves say less. Adjust your expectations accordingly. Rather than ride the emotional waves from moment to moment, keep an even keel and look longer term. Time, perspective and a level head are an investor’s best tools in rough market stretches.