June Commentary - Playing Offense in a Bear Market

Jill Green |

Written by Scott Schaeffer

 

Playing Offense in a Bear Market

As an investor, if you’ve been feeling a little anxious recently, take some comfort in knowing you are joined by millions of others. The rally in stocks that had been boosting retirement fund balances sputtered early this year, but it came to a sharp end on June 13th. That’s when the S&P 500 finally slipped into a bear market, which is defined as a market close at least 20% below its peak.

 

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Admittedly, it probably feels much worse than that for many investors—and it has for a while. The handful of well-known tech stocks that served as jet fuel for the overall market have fallen much harder since the S&P’s Jan. 3rd peak, with Meta Platforms (formerly known as Facebook) down more than 58%, Amazon.com falling 45%, and Microsoft, Apple, and Alphabet all losing about a 30% of their value.

As of the June 16th market close, the growth-stock driven Nasdaq Composite Index, which has been in a bear market since March, is down 34% from its high last year. And, for those who decided to widen their lens to include cryptocurrency…well, there’s a lot of pain out there. All these pains and declines can make us more emotional investors, whether we realize it or not.

Examples of how to “Play Offense in a Bear Market?”

 

Your best response to a bear market is likely to simply stick with your plan

If you are continuing to invest a bit of your paycheck each month, you are actually buying shares of stocks more cheaply now. In a raw sense, it’s fair to make the analogy that stocks now are at similar prices to Halloween candy on November 15th.

Although we’ve seen the S&P 500 index fall 24%, keep in mind that can quickly overshadow the fact that the index has still returned, with dividends, almost 70% over the past five years. If you’ve been steadily investing in a diversified portfolio for years, you don’t need to be beating yourself up over any pain you’re experiencing right now.

The unease you may be feeling can serve a purpose if it leads you to take a hard look at the makeup of your portfolio and the level of risk it carries. It’s worth considering whether you really are comfortable with your current risk tolerance and if it’s likely to serve you well across many market cycles, not just during bull runs.


 

Although your equity positions may be down, you do not actually lock in “losses” until you sell the positions

For example, if you still have a good portion in tech stocks, you may not want to aggressively sell now that they are cheaper. Instead, use this time as a lesson and consider making a specific sector less dominant in your portfolio in the future.

Let’s use this logic and relate it to our current situation. While tech has been hit hard, which sectors are doing well now? Driven by the supply shock created by the end of pandemic lockdowns and Russia’s war on Ukraine, energy stocks on the S&P 500 have returned more than 50% this year. Sure, there’s a case that onetime deep-value stocks like these still have a way to run…but increasing exposure to any winning stocks or sectors should be coupled with some level of caution.

Diversification is still as important as ever. Unfortunately, bonds are losing money in this equity bear market, too. On a positive note, while the prices of bonds in portfolios are dropping, the yields they are paying are finally rising from rock-bottom levels. That strengthens the argument for bonds as diversifiers now.


 

What about retreating into cash? Well—it’s simply too hard for most people, including professionals, to correctly guess when markets will turn

However, while we’re discussing cash, it may be beneficial for you, if retired, to rely on cash reserves for a short period of time. Taking withdrawals from retirement or investment accounts while the market is down guarantees that money will not be able to realize the benefit of an eventual market rebound.

This bear market has served as a reminder that for those in retirement or nearing it, having a good slug of cash is smart. For individuals who are still working, we may recommend three to six months of liquidity in cash, but we would potentially bump that to a year’s worth of income for those who are retired. “Cash” doesn’t mean only money in the bank. It could include liquidity available through a home equity line of credit for an emergency, or money held in CDs or other short-term liquid savings vehicles.

Having cash reserved could provide an alternate source of income while we wait for the market to rebound. Younger individuals may choose to invest extra dollars at this time from their regular paychecks in order to buy additional shares while equities are down. Those who are retired may choose to pause their retirement account withdrawals to allow their portfolio time to rebound. Reducing your withdrawals and/or tapping cash funds for living expenses takes the pressure of the portfolio. This allows you to take gains during the next bull market, from your long-term/stock bucket and replenish your cash bucket.


 

Consider a shift to dividend paying stocks

Dividend stocks pay out a portion of a company’s profit back to the investor in the form of a dividend, so even if the stock price falls, investors can still receive income. Dividend stocks also tend to be less volatile than the average stock. For some, bear markets create an opportunity to take advantage of Roth IRA conversions. For example, let’s say you own various investments (i.e., stocks, ETFs or mutual funds) that you declined 50% to $50,000, but you believe they still have tremendous upside potential in the years ahead. Then you can convert these investments from your IRA to a Roth IRA and pay the federal and state taxes on the $50,000. If you are able to pay the taxes out of pocket, now you have $50,000 in the same investments that will grow tax-free going forward.

Thus, if these investments were to perform well and run up say 155%, which is the normal aggregate gain during a bull market, as outlined in the chart on the next page, then your $50,000 has now grown to $127,500. The gains, withdrawals, and income from the Roth IRA are completely tax-free. Under the right circumstances, it is possible to make shrewd tax moves during bear markets.


 

Reallocate

It may make sense to sell and take a loss on one security and reallocate the proceeds toward another security that offers better growth prospects and/or total returns going forward. Let’s use the hypothetical example that you have a taxable account and own General Electric (GE), which is down $10,000 from what you paid for it, and it pays a .47% dividend and replace it with Emerson Electric (EMR) which pays a 2.43% dividend. You can take the tax loss on GE, begin collecting a 5X higher dividend payout on EMR. There are times where you can make lemonade out of lemons.

 

Final Thoughts: Bear Markets are Historically much Shorter than Bull Markets

As evidenced by the chart below, bear markets, such as the one we are experiencing now, are typically quick and painful, lasting only about 11.3 months on average. In contrast, bull markets are historically much slower and plodding, lasting periods of close to 4.5 years on average. Another way to look at it, historically from for the 80-year period 1/1/1942 – 12/31/2021, the stock market is experiencing a bull market 80% of the time and is bear market territory only 20%. If history is any indication, investors who are able to withstand the band-aid rip the market has given us recently will reap benefits on the rebound.

As the saying goes, this too shall pass; however, if you have concerns in the meantime, please feel free to contact us. We are happy to address them and any questions you may have. In addition, please consider checking out Integrity Advisory’s Facebook page. We list timely articles, videos and information that can help you stay the course.

Lastly, we now offer  “20 Minute – Ask Us Anything” sessions. Oftentimes in life, you may have a quick question as it pertains to your personal finances. In those instances, you may not know where to turn. Let us be a resource at those times. You can contact us to set up a time to talk. Please feel free to share this service with your children, relatives, co-workers and friends.

 

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References:

1. https://www.bankrate.com/investing/what-is-a-bear-market/

2. https://www.bloomberg.com/news/articles/2022-06-13/what-to-do-during-a-bear-market-stay-calm

3. https://www.marketwatch.com/picks/70-of-economists-in-a-new-poll-say-america-is-headed-for-a-recession-in-2023-heres-how-pros-say-to-approach-investing-in-light-of-that-01655243151?siteid=yhoof2&tesla=y