Best to Prepare for the Bear While Times Are Still Good
Gasoline gets more expensive, and a national witch hunt ensues to find the culprit. “It’s just market forces,” the oil companies plead. But naturally, nobody buying unleaded is buying that explanation.
Leap ahead a year or so. Let’s assume U.S. stocks are in the throes of a bear market and the Dow Jones industrial average is down about 25% from its peak of last month.
Nothing out of the ordinary about a decline like that, historically. “It’s just market forces,” Wall Street says.
But the public is hopping mad and demanding redress. Lawsuits are multiplying like bacteria. Congress launches inquiries. How could this plunge occur so soon after individual investors pumped record amounts of their life savings into mutual funds, lawmakers ask?
It would be nice to think that such a scenario will remain fictional--not the inevitable bear market part, but the above-described reaction to it. Most small investors, surveys continue to suggest, aren’t troubled by market declines. Most people, in fact, supposedly would welcome lower stock prices so they can buy more.
But that’s very easy to say when stocks are near record highs, as most are now. It’s also easy to say in the sixth year of a bull market that has pulled in more new investors than ever, most of whom have never had the opportunity to be tested by a genuine bear market.
Consider: Fidelity Investments, the mutual fund titan, had $99 billion in assets under management before the last bear market, in 1990. Today it has $399 billion. So three out of four Fidelity dollars have never witnessed a 15% broad market decline, which is the classic definition of a bear market.
Why worry about a sharp drop in stocks now? After all, Friday was another brilliant day for the market: The government’s report on April wholesale inflation was lower than expected, triggering a plunge in bond yields and fueling another rush into stocks.
Some investors, no doubt, are getting tired of hearing about the possibility of a broad pullback in the market. Wall Street has been waiting for a mere “correction”--a 10% drop in market indexes like the Dow--since this bull market began in 1990. The Dow came close to losing 10% in the spring of 1994, as interest rates jumped, but the slide stopped short.
Many individual stocks have suffered 10% declines, or worse, along the way. Yet the market as a whole has been a juggernaut, and the average stock mutual fund owner since 1990 has experienced only heady gains interspersed with the occasional 2% to 6% giveback.
Maybe this goes on for the rest of this century. But note: Many of the typical signs of excessive speculation that signal a peaking market are in evidence today, including the rising fervor for little-known stocks. Also, age is not on the bull’s side: The older it gets, the greater the odds that a shock of some kind--probably something out of the blue--will trip it hard. The time for investors to think about and plan for that possibility is now, as the good times roll, not when the market is plummeting.
This is not a gloom-and-doom forecast. The issue is simply whether a standard, temporary bear market (there have been nine just since 1955) could so shock many investors that they would find themselves paralyzed or sickened or running for legal help.
Exactly how would you react to a 1,000-point fall in the Dow index, a 20% or so decline that happens over weeks or months?
Byron Wien, investment strategist at brokerage Morgan Stanley & Co., essentially posed that question to Morgan’s well-heeled clients in a recent report titled, “The Coming 1,000 Point Decline.”
Wien and Morgan aren’t perpetual bears, understand. (For a brokerage, that wouldn’t be very good for business.) Wien had been quite bullish on the market in 1995, and correctly so. But now he’s worried about a lot of things: the sharp jump in bond yields this year; the surge in new stock offerings, as companies rush to go public; and the sustainability of the record cash inflows to stock mutual funds.
Many investors assume that only an economic recession, or the fear of one, can trigger a big drop in stock prices. In fact, history shows that the market can tumble for any number of reasons--or none at all.
Could you handle a bear market? Ask yourself a few questions:
* What percentage loss on your stock investments could you truly afford, emotionally and financially? If your stocks fell 15% in value, would it matter? What about 25%?
Put it in dollar terms: If you have a $50,000 portfolio of stocks, including any 401(k) or other retirement accounts, how much could that sum decline before you would begin to panic? If the answer is to $40,000, then you aren’t prepared for more than a 20% bear market loss. Obviously, you should be thinking now about what you would do, if anything, if your 20% loss limit were surpassed.
* When will you need your nest egg--really? Sure, everybody is a “long-term investor” these days. But if you’re a pre-retiree, and you might actually need to begin living off your portfolio within five years, a 20% or 30% decline in that portfolio in the near future might be much more troubling for you than it would be for a younger investor with more time to wait for the market to make up its losses.
* Can you confidently say that your investments match your risk profile? In other words, are you diversified enough (among stocks, bonds, money market accounts, etc.) to lower the chances that losses in any particular investment will cause you to upend your investment plan or your lifestyle?
Considering all of this, you may decide that you are indeed prepared for the bear. If so, congratulations.
If you’re beginning to doubt your preparedness, however, there is plenty you can do: sell some of your stocks, begin to boost your “cash” assets, maybe shift some assets into bonds at today’s high yields. The idea isn’t to panic out of stocks, but rather to take steps now to make sure you won’t do exactly that later.
