Yellowstone Financial, Inc.

Use the Calm to Prepare for the Bear

We are in the midst of a rather extraordinary stretch of smooth and positive stock market returns.  It’s been well over a year since we last saw a 5 percent pullback in the S&P 500, dating back to Brexit in June of last year.  This spate of peaceful markets is rare.  According to Guggenheim investments, we’ve had 5 percent pullbacks in the S&P 500 about once every 7 or 8 months on average since 1945.  We’re nearing a date that would double this average quiet period.

Once you apply more traditional descriptions of poor stock markets namely a correction (10 percent decline from the top) and a bear market (a 20 percent decline), our current market looks even more unusual.  We haven’t seen a bear market since the -57 percent historic mauling of 2007-2009, and our last correction ended in February 2016.

Accompanying this sanguine market has been more public political rancor than in recent memory.  For many it’s almost as if there are two different worlds – the financial one that marches along seemingly indifferent the volatile political one.

My point is not that the US market will soon decline to match the lack of progress on promised national legislative reforms.  It’s rather that we as investors have become accustomed to a market almost bereft of volatility.  Being an intelligent investor is much like many other professions that demand cool, rational execution in infrequent periods of high anxiety.

You don’t pay the captain to watch the autopilot while cruising at 30,000 feet, but rather to employ all of their training and practice to safely land the plane in a vicious crosswind.  Firefighters, police officers, and members of our armed forces drill regularly for situations that may never happen in their careers but would require them to respond correctly to carry out their duties.

With the recent market calm now is time for you to perform your own market drill.  How would you react in the face of a 20 percent decline in the stock market?  If you’re far from your retirement date with many years of saving and accumulating ahead of you, this exercise may be less important.  You kept saving through the last bear market, and you see no reason why the next would be different.

The investors who need to drill the most are those who have the end of their working lives in their sights.  The transition from the accumulation stage to the distribution stage of an investor’s life is traumatic for many.  After all your psychological strength as an investor may be primarily derived from faith in your ability to keep working and saving regardless of stock market conditions.  But what served while you were working may not support you when you’re depending on your portfolio to provide a comfortable stream of cash flow for the rest of your life.

When the next market decline comes, you need to be prepared to purchase back into the stock market as your portfolio declines.  When mutual fund giant Vanguard released its Advisor Alpha study a few years ago, it found the most valuable aspect of working with qualified financial advisor was the counsel offered to effect positive investor behavior in a variety of market conditions.  You may advise yourself, rely upon a professional financial planner or investment manager, work with broker, or use a virtual robo-advisor service.  Whatever your choice, be sure now when it’s calm that when the tumultuous time comes that the advice will be sound, and that you will follow said advice.   After all, the historical record is strong if you can stick with a balanced, diversified portfolio with periodic rebalancing for at least a five year period.  The challenge is getting through that period while executing well and avoiding the big mistake.