As of February 17, 2016, the stock market in the United States as measured by the broad based indices was off some 25 percent from its highs of May 2015,1 which meant we are in fact, in a bear market. Bear markets, like bears themselves, tend to scare people.
When confronted by a fierce predator or a volatile market, people exhibit the most primal of fear-driven behaviors: flight or fright.
For these fearful investors, “flight” means rushing to “unload” stocks tumbling in value, while those in “fright” mode freeze and do nothing.2 Neither panic nor inaction can save you from a real bear or the ones that invade Wall Street. But asking yourself some hard questions and giving honest answers can help start the process of keeping you on track toward your goals and objectives. To begin:
“What have I learned from the past year and what am I willing to do differently going forward?”
The past year should have taught us that today we are not dealing with your father’s market—that line-drive raging bull of a market in the 1990s where buy and hold made inimitable sense. No, this is more of a “sloppy and choppy” market, one that, yes, requires us to resist panic but one that may also penalize passivity in my view.
It is no surprise that this type of market may likely produce a lot of “white knuckle investors” who, in my opinion, are decidedly more risk averse than usual. But this is not a time to sit still and hope things get better. Opportunity knocks only if you build a door first. So, while keeping one’s cool and “staying the course” is essential, a portfolio must stay vibrant and active, and one must make carefully calculated course adjustments. This brings us to another question we suggest you ask yourself:
“What do I own, and why do I own it?”
Do you own green bananas or brown bananas? Owning something a bit early—a green banana—is fine but owning something too late—a brown banana—usually is not. And a bear market can expose weak underpinnings in some of your “brown banana” holdings.
When fearful investors lose their cool, they are likely to sell off stock in well financed and managed companies temporarily shaken by the market. You can and should purchase the stock of those firms that in all likelihood will return to their “right” value after the downturn. This is the time, as Mr. Buffett counsels, when you should get “greedy.” This brings us to the final question to ask yourself:
“Have I re-examined my portfolio’s asset allocation in light of the bear market?”
Given the effect of the bear market, your portfolio may have likely gone from, say, a ratio of 80 stocks/20 bonds to a 70/30 split. And while selling stocks at their peak value to buy more bonds might have made sense nine months ago, I believe it doesn’t now when your equities are temporarily lower in value. But boosting your equity ratio by buying fearful investors’ strong but devalued stocks may make sense. And that move should likely pay off after the downturn.
In sum, I believe that while actively recalibrating your portfolio during bull markets may potentially help deliver the better returns, doing so during bear markets can help you take advantage of the market’s inevitable rebound.
1 Bloomberg, Russell 2000 Index, February 18, 2016 versus May 20, 2015
2 Bloomberg, AAIIBEAR Index, February 18, 2016
Mark C. Hutchinson is a Financial Advisor with UBS Financial Services Inc. a subsidiary of UBS AG. Member FINRA/SIPC in Chicago. UBS Financial Services Inc. Financial Advisor(s) engage Worth to feature this article. As a firm providing wealth management services to clients, we offer both investment advisory and brokerage services. These services are separate and distinct, differ in material ways and are governed by different laws and separate contracts. For more information on the distinctions between our brokerage and investment advisory services, please speak with your Financial Advisor or visit our website at ubs.com/workingwithus. Asset allocation does not guarantee a profit or protect against a loss in a declining financial market. The strategies and/or investments referenced may not be suitable for all investors. UBS Financial Services Inc., its affiliates and its employees are not in the business of providing tax or legal advice. Clients should seek advice based on their particular circumstances from an independent tax advisor. The views expressed herein are those of the author and may not necessarily reflect the views of UBS Financial Services Inc. Member FINRA/SIPC. Past Performance is no guarantee of future results.
This article was originally published in the April/May 2016 issue of Worth.