You can’t predict a market decline, but you can prepare for it

By Robert Bacarella | September 13, 2019

The current secular bull market is now one of the longest on record. This current economic cycle has been unique given the modest level of economic growth which has kept interest rates and inflation low. Also, corporate profitability has benefited from lower corporate tax rates, reduced government regulations and higher consumer spending levels.

Many investors believe that the bull market is far from over as reflected by such comments as;

* “We are only in the fifth inning;”

* “Markets die of euphoria and we’re nowhere near euphoria;”

* “No big inventory bubbles;” or

*“The consumer is in great shape.”

It’s true that business cycles do not end from old age alone. They tend to unravel in conjunction with economic excesses, a geo-political event, monetary policy changes or other factors that investors believe could impact future economic growth

The fact is no-one knows when or what will trigger a market correction. Stock market declines are a natural part of the investing cycle and it is nearly impossible to tell if a market decline is a temporary dip or the beginning of a more prolonged contraction. When a bull market does actually ends, the light can change from green to red without pausing at yellow.

The right frame of mind for market downturns

Taking money out of the market in anticipation of or during a market declines means that if you don’t get back in at the right time, you could miss the full benefit of market recoveries. Historically, returns in the first year after each market decline have ranged from 36.16% to 137.60%, averaging 70.95% for the period 1929-2016*. In that successful market timing has proven to be very difficult, is it worth the risk? Some investors also consider shifting funds to more defensive assets to protect value but this strategy does not ensure against portfolio losses.

We realize it’s easy to say that volatility and market declines work themselves out over time. But research has shown that watching losses occur feels twice as bad as watching gains feels good. That means people are prone to making emotion-based decisions to “stop the pain” in down markets-even if it works against them longer-term. Although recoveries are not guaranteed, they have always happened in the past. So, although it could take months or years to recover from a loss, remember that it’s time in the market, not timing the market that matters most.

So, what does an investor do if worried about losing money?

If you are concerned about preserving your portfolio value a good defensive strategy is shifting a “portion” of your portfolio to cash. For example, think of your portfolio as our solar system. The Sun, represented by the S&P 500 Index, is the center or core that is always there, generating a market return. The planets, represented by individual stock investments, tend to be more risky than the core, diversified portfolio. They can be considered a source of funds, if you believe a defensive strategy is called for. This view of “defense” is not about timing the market. Rather, it’s about preserving value on a portion of your portfolio, helping you to reduce risk and “sleep better at night.”

The extent to which you shift your portfolio to cash will depend on your risk tolerance level. We believe most investors should always stay invested in the core portion of their portfolio and limit sales to their “planetary” investments. With some cash on the sideline you could now have an opportunity to purchase quality companies at depressed valuations, when they go on “sale.” You’ll know you have the right asset allocation mix when instead of fearing a market decline you look forward to it as a buying opportunity.