The coming of a bear market is inevitable, but it is doubtful that you are prepared for it. The reason, I believe, is that the bear market you envision is not likely to be the one that occurs at all. Many bear markets are cyclical, and can occur with a sudden crash only to recover almost as quickly, as in October of 1987. Others can be decades-long deflationary grinds that demoralize even the hardiest of bulls, and that can make an entire generation swear off equity investing, such as the current market in Japan.
Some bear markets are stealthier, and carry the appearance of a bull, but are actually vicious bears. That is because inflation consumes all of the nominal returns, leaving investors with nothing for themselves. Such was the case with the S&P 500 from January of 1970 through 1980, when the S&P 500 returned about 8% nominally, but virtually nothing after inflation.
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When the next bear market does occur – whatever form it takes – and you do find yourself ill prepared, you can blame these poor investment decisions:
- Tired of the negligible returns on cash, you raided your savings account to buy more shares of your Vanguard index fund, so when the market crash did occur, you were forced to sell at inopportune prices, therefore locking in steep losses.
- Worried about the strong dollar and the recent crash it caused in oil prices, you sold your energy shares and hedged your foreign equities, leaving you with an equity portfolio entirely dependent on dollar strength for continued performance, leaving you unhedged against an unexpected dollar decline and a subsequent rise in inflation.
- Fearing inflation and rising rates, you sold all of your bond positions, so when a bout of Japanese-style deflation set in, your portfolio got crushed.
- After years of watching the S&P 500 outperform the rest of the global marketplace, you cashed out of your foreign and emerging market equities to go all-in on US stocks, just in time for the cycle to turn.
There is, however, another form of bear market, and, in my opinion, it is the most pernicious one of all. That is the bear market that you inflicted it on yourself. That is because, riddled with fear of all the terrible things (such as those above) that could happen to your portfolio, you never invested at all, suffering a massive drawdown in opportunity cost. Those foregone gains can never be made good, as time, your main ally as an investor, is a non-renewable resource, and you have squandered what time was allotted you.
The point of this post is that the future will likely be scarier than we think. Nobody can predict with any degree of accuracy what is likely to occur, but prudent investors assign probabilities to those unforeseen events most likely to occur, and diversify their portfolios accordingly. It is repeated so often by advisors that it is a broken record. Yet it is the only way that investors can give themselves a fighting chance against whatever unpleasantness comes their way. If you follow this prudent advice, your chances of living to fight another day will be greatly increased, even though your chances of predicting what exactly will happen are nil.
Disclosure: The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index.
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By Lawrence Hamtil of Fortune Financial Advisors