Ten years ago, in 2008, we were in the middle of a worldwide financial crisis. I personally will never forget that time and its effects on me and the clients of New England Capital. I have been reliving this time, almost day-by-day, with the help of a book I am currently reading. A friend and client (thank you Don) lent me former Federal Reserve Chairman Ben Bernanke’s book called “The Courage to Act: A Memoir of the Crisis and Its Aftermath”.
Like many financial crises before it, excessive debt can be at least partially to blame for this “Subprime Crisis”. Simply put, people, companies and countries get themselves into trouble by borrowing more than they can afford to pay back. As Bernanke said in his book, “The financial crisis of 2007-2009 had several triggers. The most important and best known is the rapid run up and subsequent collapse in housing prices and construction.”
Other triggers include risky lending practices to individuals and real estate developers. Banks and mortgage companies were incentivized to construct and sell complicated financial instruments that magnified the leverage while making these loans appear safe.
The crisis caused many weak companies to merge including Bear Sterns, Countrywide Mortgage, Washington Mutual, Wachovia and Merrill Lynch. Insurance company AIG as well as car companies like General Motors and Chrysler had to be bailed out by the US government. Investment bank Lehman Brothers, which was founded in 1850, was forced to declare bankruptcy.
The Great Recession followed this financial crisis. The stock market as measured by the Standard and Poor’s 500 (S&P 500), which lost 56.4% from October 9, 2007 to March 5, 2009, has technically been in a bull market ever since. I say technically because a bear market is defined as a 20% or more decline from top to bottom in a particular index like the S&P 500. In the six months from May to October 2011, the S&P was down 21.6%.
So why wasn’t this a bear market? Because - and this is the technical part - the 21.6% decline was based on intra-day moves, not end-of-day 4pm closing values. The closing day decline was 19.4% thereby barely missing the strict definition of a bear market.
Again, during mid-2015 to early 2016, while the S&P 500 never closed down 20%, the average stock in that index declined more than 25%. The other widely known stock market index, the Dow Jones, was down more than 32% during the same time. Therefore, as anyone who has been invested in the stock market for the last 10 years knows, while it has been a very good time to be an investor, it has also been a time of market ups and downs.
Historically bear markets average a decline of -33% and last 14 months. The average bull market, or up market, averages an appreciation of +268% and lasts 70 months.
The stock market is considered a leading economic indicator. This means it tends to “predict” future economic activity. Currently, there is no consensus that the US or world economy are on the verge of plunging into a recession. In fact, there isn’t much evidence of things that would be corrected by a recession including high inflation, extreme levels of debt, large unsold inventories of goods, or rich stock market valuations. I don’t believe that stocks are cheap, but I also don’t think they’re excessively expensive. I know stock market indexes have recently hit new highs but corporate earnings have hit new highs too. Hitting all time stock market highs don’t necessarily mean that stocks are about to crash. In fact, more than 70% of the time after we experience a new stock market high, it is followed by another new high. And historically, every new market high has been eventually surpassed by another new high.
Armed with this information, what should you do now before the next bear market? Please note I am not trying to prepare you IF we have a bear market; I want to prepare you for WHEN the next bear market happens.
Here’s a list of ideas that can help you survive the next market downturn.
- Be diversified – Avoid being overly concentrated in one stock, one bond, one asset class or sector (i.e. owning only technology companies) or one geographic area (i.e. owning only US companies or only emerging market companies).
- Rebalance – If you decided your balanced portfolio in 2009 should be a mix of 60% stocks and 40% bonds AND you have not rebalanced, you could now be closer to 80% stocks and 20% bonds. This is a much more aggressive mix than you originally planned.
- Invest for total return, not yield – I’ve seen too many people hurt themselves by chasing the highest current yielding investment instead of approaching their portfolio with regard for total long term returns.
- Know there are different types of risk – An investment that allows your principal to fluctuate could be a poor short-term investment but a great long-term investment designed to protect you against the risk of inflation. Longevity risk is often overlooked. On average (and all of my clients are above average!) you’ll spend 8000 days in retirement. The cost of food, energy, taxes, etc. will undoubtedly be greater towards the end of those 8000 days than in the beginning. Now you know why we need to guard against inflation or purchasing power risk, not just principal risk.
- Understand and apply the new tax law – Old tax strategies won’t be as helpful under the new law. We need to adjust our thinking around charitable giving, required distributions from IRAs and interest deductions from mortgages and home equity loans.
- Finally, understand what’s in your control – If you’re still in the accumulation phase of life, be prepared to increase your savings rate during market declines. Know ahead of time that this is an emotionally difficult thing to do. If you’re in the distribution phase of your life, beware of your spending rate. Splurge a little while the market’s up. Remodel or travel internationally. But reign in spending if the market drops. Eat at home more or try the staycation closer to home during the market down turns.
As always, call us to review your unique situation. We’re here to help in good times and in bad. And remember that neither lasts forever.