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Enjoy the Market Rally, But Prepare for the Retreat!

Investors may be lulled into a false sense of security by this market.

Will the current bull market run for another year? How about another two or three years? Some investors will confidently say “yes” to both questions. Optimism abounds on Wall Street: the major indices climb more than they retreat, and they have attained new peaks. On average, the S&P 500 has gained nearly 15% a year for the past eight years.

Stocks will correct at some point. A bear market could even emerge. Is your investment portfolio ready for either kind of event?

It may not be. Your portfolio could be over weighed in stocks and stock mutual funds – that is, a higher percentage of your invested assets may be held in equities than what your investment strategy outlines. As your stock market exposure grows greater and greater, the less diversified your bull market and bear marketportfolio becomes, and the more stock market risk you assume.

You know diversification is important, especially when one investment sector that has done well for you suddenly turns sideways or plummets. When a bull market becomes as celebratory as this one, that lesson risks being lost.

How do bear markets begin?

They seldom arrive abruptly, but some telltale signs may hint that one is ahead. Notable declines or disappointments in corporate profits and quickly rising interest rates are but two potential indicators. If the pace of raising rates speeds up at the Federal Reserve, borrowing costs will climb not only for households, but also for big businesses. A pervasive bullishness – irrational exuberance, by some definitions – that helps to send the CBOE VIX down to unusual lows and can be seen as another indicator of a bear market or stock correction.

How long could the next bear market last?

It is impossible to say, but we do know that the longest bear market on record lasted 929 days (calendar days, not trading days). That was the 2000-02 bear. A typical bear market lasts 9-14 months.

Enjoy this record-setting Wall Street run, but be pragmatic.

Equities do have bad years, and bears do come out of hibernation from time to time. Patience and adequate diversification may make a downturn more tolerable for you. You certainly do not want the value of your portfolio to fall drastically in the years preceding your retirement.  If this happens, you will have a narrow window of time to try and recoup that loss. Remember, the market does not always advance. It may be time to lock in these gains or re balance your portfolio.

Be careful listening to the media.

So while 15% gains sound great, way over 200% gains without a significant correction; the average annual return since the 2000 bear market has been only 4.11% (without dividends). Adjust for inflation and the return goes down to 1.90%. Minus out taxes, management fees, brokers fees and expenses and it seems like those that have been in the market since 2000 are still losing money.

The coming correction is right around the corner. Be Proactive, Not Reactive. Our clients didn’t lose a dime in 2000 or 2008. How low can it go? That’s anyone’s guess but this guy thinks it will be the Worst Stock Market Crash Ever… and that would be pretty bad.

Stock Market

Bull Market

Looking Beyond the Current Bull Market

When the latest bull market for U.S. stocks reached the five-year mark on March 10, 2014, only five bulls had lasted longer. The Standard & Poor’s 500 index posted a gain of 177% for the five-year period.1

The current bull followed on the heels of the Great Recession and the worst stock market decline since the 1929 stock market crash. The most recent bear market began in October 2007; the S&P 500 fell 57% before hitting the bottom on March 9, 2009.2

In typical fashion, investors who sold stocks during the downturn may not have participated fully in some of the subsequent bull market gains. A recent Morningstar study found that emotional trading practices had a negative effect on investment returns over the last decade. For the 10-year period ending December 31, 2013, investor dollars returned an average of 2.5 percentage points per year less than the average mutual fund’s performance, largely because people have a tendency to buy high and sell low.3

bull-market

Looking Back
A bull market is often defined as a period in which asset prices rise 20% or more without a drop of 20% in between. A price decline of 20% is called a bear market. Most of Wall Street’s worst bear markets have been caused by recessions, but history shows each bull and bear market to be different.

  • The longest and most profitable bull market began in late 1987 and lasted until the tech bubble burst in 2000, posting a 582% gain.4
  • During one rough period from late April to early October 2011, the S&P 500 lost 19.4% based on closing prices. However, the index actually dropped below the 20% threshold for a short time during the trading day on October 3. Some people believe this resulted in a momentary bear and the beginning of a new bull market.5
  • There have been a total of 12 bull markets since the end of World War II (including the current one). Half of those lasted five years, and only three made it to a sixth year.6

Room to Run?
The terms “bull” and “bear” are also used to describe the positive or negative outlook of individual investors.

Some bearish investors believe central bank policies have helped sustain the bull market, and that stocks could suffer as the Fed cuts back on monetary stimulus. Moreover, price increases have outpaced earnings growth, making stocks more expensive relative to corporate profits. The S&P 500 traded at about 16 times earnings over the past year, which is about twice the level five years ago.7

On the positive side of this perpetual argument, bulls point out that the stock market has been rising from generational lows and could climb further if economic growth picks up speed.8 Stock prices generally reflect economic conditions and the financial performance of individual companies.

Volatility Resumes
The S&P 500 posted a 32% total return for 2013, the largest in 16 years.9 Thus far in 2014, the stock market has been bumpier. The S&P 500 index experienced 11 market swings of 1% or more through mid-March. By and large, these sell-offs and relief rallies were in response to news about monetary policy, the Ukrainian conflict, and signs of economic weakness in China and other fragile economies.10

Even professionals have a difficult time predicting market turning points, so investors may hinder themselves by changing course based on current events or recent performance.

Though it may be human nature to be wary of stocks during a bear market, a long bull market might tempt investors to invest too aggressively. For this reason, you might want to pay less attention to the market’s ups and downs and stick with a long-term strategy based on your time horizon, risk tolerance, and financial goals.

The return and principal value of stocks fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost. The S&P 500 is an unmanaged group of securities that is considered representative of the U.S. stock market in general. The performance of an unmanaged index is not indicative of the performance of any specific investment. Individuals cannot invest directly in an index. Past performance is no guarantee of future results; actual results will vary.

For more information on this topic please contact Ben Borden Richmond, Va Financial Advisor, (804) 282-8820

 1–2, 6) MarketWatch, March 7, 2013
 3) Kiplinger, March 12, 2014
 4) CFA Institute, December 2013
 5) The New York Times, March 24, 2012
 7) The Wall Street Journal, March 8, 2014
 8) Kiplinger’s Personal Finance, January 2014
 9) The Wall Street Journal, March 16, 2014
 10) CNNMoney, March 18, 2014
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