Bear market do’s and don’ts

03-23-2020
Bear market do’s and don’ts

How to cope with a market meltdown

 

We’ve never experienced anything like this in our lifetimes. A tiny virus has pushed the global economy to the edge of recession, killed the longest bull market in history, disrupted our daily lives, and, worst of all, been a death sentence for thousands with the numbers growing daily.

When I was a boy during the Second World War, I recall seeing a sign on a store that read “Closed for the duration.” That’s how life seems today – everything is closed for the duration of this outbreak, however long that may be. Whole countries are on lock-down, with more undoubtedly to come. Airlines have grounded planes and cruise ships stand empty at their piers. People are reluctant to venture out of their homes, even to buy the basics. All the major sports leagues have suspended play.

Life as we used to know it has vanished overnight. Who knows when we’ll see it again.

This special report was written in mid-March. Events are evolving so quickly that some of this material may already be outdated by the time you read it. But I hope you will find the basic advice to be useful to you in these troubled times.

The new bear market

The longest bull market in history has ended, almost 11 years to the day from its start. The plunge has shocked investors, coming less than a month after the major U.S. indexes hit record highs.

We’re now in bear market territory for the first time since the financial crisis. The main questions are how low the markets will go and how long this will last.

History tells us that bear markets tend to be short-lived (about 10 months is the norm), with an average price drop of 36%. The 2007-09 crash was longer (1.3 years according to Investopedia) and deeper (the S&P 500 dropped 50.9% before the carnage was over).

But these are not normal times. No one knows how long the coronavirus crisis will continue or what its ultimate impact on the economy will be. It seems clear that it will plunge the world into a recession – we may be there now, but we’ll have to await the numbers for verification. But how deep will it be and how long it will continue is a matter of pure speculation.

Optimists are hoping for a V-shaped recovery. That’s based on the unproven theory the virus will be slowed by the advent of warmer weather and the economy will snap back in the second half. Pessimists see the virus continuing to spread and an Italian-like shutdown in most parts of the world that continues for many months.

In the face of such uncertainty, what should you do?

First, remember that at some point the bear market will end. It always does. Sound companies will still be in business, and their stocks will be selling at rock-bottom prices.

Looking back at the financial crisis, investors who held on were richly rewarded when the stock market rebounded. Those who locked in losses took years to recover, and some never did.

If you’ve followed my advice over the years, you have a balanced portfolio that includes a high percentage of bonds, dividend-paying stocks, and some cash. If that is the case, I suggest you take a deep breath and prepare to ride this out. The overall value of your holdings may fall but the bonds will cushion the shock and the dividends will provide cash flow. The time to start to deploy any cash will be when the market rebounds 20% from its low, a signal that a new bull may be underway.

If, on the other hand, you’re holding a lot of marginal securities, you may have to consider trimming your losses whenever there is a rally. Those stocks tend to underperform the broad market in turbulent times as speculators bail out.

Everyone is living with a lot of stress these days – both financial and health wise. You need to do whatever you can to reduce that stress level. The Wall Street Journal noted in a recent coronavirus section that stress weakens the immune system, making people more vulnerable to illness.

Health has always been more important than money. The bear market will eventually be history and the value of your portfolio will recover. Keep that in mind in the days to come.

Bear market dos and don’ts

Don’t sell quality. Think back to what happened in the fall of 2008. Even the best companies lost value as the entire market collapsed. But once the blood-letting ended in early March 2009, almost all these stocks came back and eventually went on to new highs. Anyone with some cash available could have doubled their money in a couple of years by investing in blue-chip stocks near the bottom.

Do sell speculative issues. I never recommend buying speculative stocks, but some people can’t resist in the hope of scoring a huge gain. In a buoyant market, that can happen. But when everything is selling off, it’s far less likely. In fact, some borderline companies may go under if things get too bad, leaving you holding an empty bag. Better to take a hit now than to lose it all.

Do keep bonds. After last year’s strong gain of almost 7% in the FTSE Canadian Universe Bond Index, spurred by falling interest rates, there didn’t seem to be much upside left for 2020.

But those calculations did not consider the impact on the bond market of something like the novel coronavirus. Investors have been scrambling for safety, pushing yields down and raising bond prices. (Yields and prices move in opposite directions.)

At the time of writing, the FTSE Universe Bond Index was up about 3% year-to-date, much better than the TSX. The main exception is high-yield bonds, which were showing a loss year-to-date. Default risks for marginal companies rises during times of economic stress, putting downward pressure on their bond issues.

Bond ETFs are the best choice for most people. The iShares Core Canadian Universe Bond Index ETF (TSX: XBB), which reflects the performance of the underlying index, has been a recommendation of both our newsletters for many years.

Do own gold. Like bonds, gold is considered a safe haven in times like these. The precious metal took a beating in mid-March, with the price dropping more than US$100. But I expect it to recover the longer this crisis lasts.

Don’t try to time a recovery. We have no way of knowing how long the virus will remain a disruptive force. Some health officials believe the coming of spring and warmer temperatures may slow it down, but that’s an untested theory at this point. If you have some cash to invest, keep it in reserve until the market has moved up 20% from its low. At that point, the recovery should be well established, and you can deploy your cash.

For more information and the latest updates on this rapidly evolving story, go to www.BuildingWealth.ca.

Gordon Pape is one of Canada’s best-known personal finance commentators and investment experts. He is the publisher of The Internet Wealth Builder and The Income Investor newsletters, which are available through the Building Wealth website.

For more information on subscriptions to Gordon Pape’s newsletters, check the Building Wealth website.

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Notes and Disclaimer

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The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting, or tax advice. Always seek advice from your own financial advisor before making investment decisions.