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If today’s bullish market activity comes to a head, are you prepared?
By Don Burrows
Senior Vice President
The coronavirus pandemic pushed the U.S. into a recession after nearly 11 years of economic expansion. Despite widespread economic instability, the stock markets are booming. The Nasdaq Composite Index, S&P 500, and Dow Jones Industrial Average (DJIA)1 have risen 60%, 47%, and 43%, respectively, since their lows on March 23.
Improved manufacturing data in the U.S., Europe, and China are driving the early-August rally, according to Market Watch. Yet, as we’ve seen before, a resurgence in COVID-19 infections can turn investor sentiment on a dime.
However, the million-dollar question on everyone’s mind is whether we’re still in a bear market? And if not, are we free and clear to invest like we’re in a bull market? The answer isn’t so simple, but there are some historical indicators that suggest we’re merely experiencing a bear rally.
Bear Rallies in Context
There are useful parallels that can be made between today’s market bounce and the bounces in the crash phases—or steep market drops—of 1929, 1987, and 2008 (see time table of notable bear markets below). Each crash phase was followed by a pronounced bounce back. In 1929, the DJIA retraced 36 percent of its losses; in 1987, it retraced 28 percent; and in 2008, it retraced 24 percent.
However, each bounce was also trailed by yet another drop with a protracted and sometimes choppy return to bounce levels. Parallels can be made to what’s going on in the markets today. Except we’re in the middle of a pandemic with no end in sight and further federal relief still in gridlock. And while major market indices continue to rise, our economy remains in a dire state.
As a result, it’s important to have a good understanding of what a bear market is and how to navigate one.
Bear Market Definition
A bear market is characterized by prolonged declines in stock prices—typically at least 20 percent lower than recent highs—in a market or market index like the S&P 500. Based primarily on longevity, bear markets are further categorized by either being “secular” or “cyclical.”
In a secular bear market, below average stock price declines will last several years and are often driven by long-term trends like interest rates or corporate earnings.
In a cyclical bear market, low prices and returns will persist from a few months up to a year and are often driven by adverse investor sentiment and phases of the business cycle.
Investing in a Bear Market
Given the 128-month business cycle expansion that began in June 2009, it’s safe to say many investors can’t fully recollect navigating a secular bear market. However, this type of market environment is routine—there have been 12 bear markets in the S&P 500 since 1945.
If the market turns again, the prudent action for investors is to stay calm and stick to the fundamentals:
Pay attention to risk. In a bear market, conventional market wisdom still holds true: take only as much risk as appropriate for your age and financial goals. For investors nearing or in retirement, paying special attention to your risk tolerance is paramount. In a recent survey, investors indicated that a 100 percent stock allocation 40 years before retirement was acceptable. Conversely, respondents indicated they would be comfortable with a stock allocation of as much as 40 percent nearing or in retirement.
Focus on opportunities. Losing principal in a bear market could result in an especially hard hit to your portfolio and savings. If you’re young and still in a phase of accumulation, your remaining or new assets have more time to make up for the loss. Plus, you now have the opportunity to invest in normally high-valued stocks or index funds at a lower price, positioning yourself for potentially higher earnings in the future.
Focus on protection. If you’re nearing or in retirement, remember that bear markets can cost you up to half your savings. And the assets you hold must provide a higher return to counterbalance the loss. Despite this, a bear market is not the time to take advantage of cheaper stocks. Many older investors often increase their cash position and move toward investing in assets with steadier returns, like dividend-paying stocks, bonds, and annuities.
Historical Bear Markets
Compared to bull markets, bear markets are historically short lived. However, you shouldn’t minimize the impact that a market downturn can have on your portfolio. The chart below highlights some particularly notable bear markets in the past 90 years—each of which is characterized by a sharp drop in prices and, in many cases, a recession.
Source: Global Financial Data, msnbc.com research. Accessed July 13, 2020
Refining Your Investment Strategy
Despite rising public debt, meager earnings, and an ongoing pandemic, the stock market appears to be bouncing back, due in part to the Fed’s Quantitative Easing programs and slowly improving economic data. However, how long this will last and whether or not it is sustainable has yet to be determined.
One thing hasn’t changed is that investors should approach the markets and their portfolios with an eye on their overall financial goals, time horizon, and risk tolerance. To build a financial plan that takes into account all of the above, speak to a HilltopSecurities financial professional near you or call 214.953.4000.
Hilltop Securities Inc. (HTS) is a registered broker-dealer, registered investment adviser and municipal advisor firm that does not provide tax or legal advice. This information is intended for educational and informational purposes only and does not constitute legal or investment advice. HTS is a wholly owned subsidiary of Hilltop Holdings, Inc. (NYSE: HTH) located at 1201 Elm Street, Suite 3500, Dallas, Texas 75270, (214) 859-1800. Member: NYSE/FINRA/SIPC.
1 Indexes are not managed funds, have no identifiable objectives and cannot be purchased. They do not provide an indicator of how individual investments performed in the past or how they will perform in the future. Past performance of asset classes does not guarantee the future performance of any investment. Standard & Poor's 500® Index (S&P 500®) - is comprised of 500 stocks representing major U.S. industrial sectors. Performance figures are inclusive of dividends reinvested. S&P 500 is a registered service mark of The McGraw-Hill Companies, Inc. NASDAQ Composite Index - measures all NASDAQ domestic and international based common type stocks listed on The NASDAQ Stock Market. Today the NASDAQ Composite includes over 4,000 companies, more than most other stock market indices. Because it is so broad-based, the Composite is one of the most widely followed and quoted major market indices. Dow Jones Industrial Average - The Dow Jones Industrial Average is a popular indicator of the stock market based on the average closing prices of 30 active U.S. stocks representative of the overall economy.