How to thrive in an extended market downturn

Well, it looks like the party is finally over. After decades of lower and lower interest rates, central banks around the world have determined that interest rates need to rise before inflation gets out of hand.

Unfortunately for investors, global stock markets haven’t taken the news well. At the time of writing (early June), the broad-based S&P 500 U.S. stock market index is down about 23%. Predictably, former growth sectors (technology in general, small-cap stocks, housing stocks and anything connected with either online or traditional media) have come down dramatically, while many formerly out-of-favour sectors (energy in particular, but also utilities and certain mining stocks) have risen in response.

For veteran market-watchers, this cycle from bull to bear, from popular to unpopular, from greed to fear is nothing new. But that doesn’t make the experience of going through the cycle any easier. And it does bring up an important question: what should investors do now? How can snowbirds, many of whom rely on their portfolios for income, navigate this bear market turbulence and position their portfolios for growth in the future?

Here are some tips and strategies for how you can do that. Taken together, think of the points below as your bear market game plan: a set of tangible actions which you can take to protect your portfolio in the here-and-now, and position it for success when the market finally emerges from the current malaise.

First, a little perspective…

To start off, let’s define what we’re talking about when we talk about a “bear market.” By definition, a bear market is a stock market downturn of 20% or more, as measured by the recent market top. That makes it different from a “correction,” which is typically defined as a downturn of 10-20%.

At the time of writing (early June), the U.S. market is firmly in bear market territory, down about 23%. Here in Canada, however, the TSE 60 index has fared far better, in no small part because of the tremendous performance of energy stocks – they’re only down 9%.

But these numerical definitions don’t really capture the true impact of the downturn that we’ve seen, particularly when it comes to certain sectors which have been particularly mauled by the bear. The technology-heavy Nasdaq 100 index, for example, is down fully 31%. And even that number doesn’t really do justice to the carnage that some former market darlings have seen: Facebook (now Meta Systems) down 51%; Netflix down 71%; Covid vaccine-maker Moderna down 50%, to name just a few.

What causes bear markets?

There is no one cause for bear markets, which is one of the reasons why predicting when and where they will happen is so difficult. But here are the main culprits:

Rising interest rates

As the saying goes, money makes the world go ‘round. And when the cost of borrowing the money (a cost we typically call “interest”) rises, it can become more difficult for businesses to create more products and services, expand operations and hire more staff. In a similar fashion, consumers such as you and me can find it more expensive to borrow to buy a home or a new car, or even pay off the credit card at the end of the month.

None of this is a big problem if rates rise slowly, giving businesses and people time to adjust. But when rates rise rapidly, it can create a kind of economic shock, as businesses and consumers cut back on their spending and try to account for the added cost of borrowing. Investors who try to anticipate that shock often sell shares in those businesses which will be most affected by the increased cost of borrowing money and/or the slowdown in consumer spending.

Economic slowdowns

Closely related to the above. Obviously, when consumers spend less, businesses hire fewer people, corporations sell fewer goods and services to customers and the slowdown affects corporate profits; sooner or later, the stock market reflects that weaker economy. One relatively recent example of this phenomenon would be the financial crisis of 2007-08, when a crash in U.S. housing prices spread to other sectors (particularly the financial sector) and caused a global stock sell-off.

Politics

The stock market is primarily a place of economics − but politics can have as much of an effect on stock prices as can corporate earnings. Changes in government, changes to taxation, tariffs and other regulations, and even outright war can all change the way in which investors perceive the future, which translates into what prices they’re willing to pay for stocks. The current conflict in Ukraine is one recent example.

“Black swan” events

Most of what happens in the world has been seen before in history. But every now and again, a scenario or event happens that seems to come out of nowhere, or that very few predicted. When such events happen, they can often cause a wave of worry to wash over the stock market, as investors become anxious about how business will adapt to the unexpected. Covid-19 is an obvious example here.

Reality check

Veteran market-watchers know that investing can be a very emotional activity. Most of the time, those emotions are positive: investors buy stocks because they believe that businesses will earn more profits in the future. Every now and again, however, investors do a “reality check” and re-think their positive assumptions and rosy predictions. The “tech wreck” of 2000 is a good example, when investors suddenly realized that many of the overhyped dot-com stocks were not living up to expectations and ended up selling almost everything high-tech as a result.

All of the above

Of course, it’s quite common to have multiple causes working at once. This seems to be the case right now: central banks are raising rates rapidly to combat inflation. At the same time, Russia decided to invade Ukraine. At the same time, the world is trying to recover from Covid-related supply-chain chaos. At the same time, many investors are waking up to the sky-high valuations of tech stocks, cryptocurrencies, “meme stocks” and other speculations and wondering whether a lot of the hype is, well, just hype.

When will this bear market end?

That is, of course, the big question. And here’s the simple answer: nobody knows. The best we can do is look to history for guidance, and try to determine how long the market has taken to get over past bear markets.

The chart [below] provides an overview of the bear markets on the U.S. stock market after WWII, along with how many months it would have taken an investor to break even, if they had put money into the market when the bear first reared its ugly head.

Bear Markets Since 1946

Year	Number of days	Decline amount	Months to break even
1946	353	28%	37
1948	363	21%	12
1956	446	22%	11
1961	196	28%	14
1966	240	22%	7
1968	543	36%	21
1973	630	48%	69
1980	622	27%	3
1987	101	34%	20
2000	929	49%	56
2007	517	57%	49
2020	33	34%	5

What to do about this bear market: getting your game plan together

OK, now that we have some perspective regarding what exactly bear markets are, what causes them and how long they typically last, let’s get to the real question: what to do if you find yourself in the middle of one. Here are some ideas:

1. Recognize that things have changed

First things first: get into the mental mindset of a bear market, and understand that things have changed.

In practical terms, this means that you should be prepared to accept that the strategies and ideas which worked well in the recent past probably won’t work quite as well in the new investment environment. For example, some markets that have been on a tear recently may now be in for an extended period of mediocre performance. Popular investment themes that have captured headlines (examples: electric cars; renewable energy; cryptocurrencies; pot stocks; etc.) may need to be reassessed. And stocks that have been the “darlings” of the market − think Facebook, Amazon, Netflix, Google and similar companies − may not be so well-loved going forward.

This is not to say that you’ll need to liquidate your portfolio. And it’s also not to say that these formerly hot ideas will never be hot again − maybe they will some day in the future. Rather, it’s a reminder to temper your expectations and not to assume that things will quickly return to the way they used to be.

2. Prepare for higher interest rates

Fact: the current bear market is being driven in large part by the rapid rise in interest rates. Since the start of the year, the U.S. Federal Reserve has increased their trend-setting overnight lending rate from 0.25% to 1.75%, and has signalled that more increases are in store for the rest of the year. The Bank of Canada has said that it plans to largely follow the Fed’s lead.

Rising rates require investors to understand that entire classes of businesses which excelled during times of low rates are likely to struggle as rates rise, while others will benefit, and still others probably won’t be affected much at all. Learning to understand how these different businesses work in the new environment will be an essential part of successful investing during this bear market.

The same basic truth applies to your personal circumstances. For example, if you’re a retiree whose portfolio is largely geared to bonds, GICs and other fixed-income investments − good news! Those investments will probably start paying you a lot more in interest than they have in recent years. On the other hand, if you hold a variable rate mortgage, or if your retirement portfolio is full of growth stocks, interest rates might turn out to be a real headwind for your finances. And if you’re a retiree with a balanced portfolio, who’s paid off your mortgage and has a rental property or a pension that rises a bit each year with inflation (as many former government employees do), higher interest rates might not mean much at all.

3. Review baseline expenses

Live within your means − solid financial advice at any time. But when the economy enters a period of uncertainty and stock market volatility seems to increase on a daily basis, it’s especially important wisdom to keep in mind.

To get a complete picture of your spending, you could do a full budget analysis and track every nickel in and out of your chequing account for a few months. But most of us have better things to do. Instead, take a close look at your “baseline” expenses: what you spend on housing, transportation, food and health care. These broad categories cover most of the non-discretionary spending for most snowbirds most of the time, before we think about going on a trip, dining out, buying a new gold watch, and so on.

Each broad category contains a number of expenses within it (for example, housing might include rent or mortgage payments, along with property taxes, insurance, utilities, and so on). Taken together, they’ll give you a good picture of how much cash you’ll need on a go-forward basis just for living, along with a few ideas about where you might be able to tighten your belt a bit.

4. Re-evaluate your withdrawal rate

How much should you withdraw from your retirement savings every year? Even in good times, it’s always been a tough question to answer. But it becomes even harder during a bear market, when stock market volatility means selling beaten-down investments to generate cash.

In the past, most professionals would rely on simple rules of thumb when determining an effective retirement withdrawal rate. You may have heard about the 4% rule − the assumption that retirees can reasonably withdraw up to 4% of their retirement capital in any given year without too much worry about ever running out of money (assuming an average life expectancy, reasonable spending habits, investment in a reasonably conservative portfolio that included at least some dividend-paying equities, and so on).

Given the current market environment, it’s best to consider the 4% rule as a starting point for a more detailed exploration, rather than a “set in stone” number that works for all people in all circumstances. If your portfolio generates significant income, then perhaps 4% is a good target to aim for. On the other hand, if you’re accustomed to trimming the winning positions in your portfolio in order to generate income, maybe 4% is too much − at least until the stock market sorts itself out.

5. Diversify to match your risk tolerance

If you’re a regular reader of this column, you’ll know that we’re big proponents of the benefits of diversification. Simply put, by spreading your portfolio “eggs” across many market “baskets,” you protect yourself should any one basket break. Sure, you can make a lot of money by taking concentrated positions in a small handful of investments. But, for most snowbirds, the protection of diversification is usually a lot more important than the chance of striking it filthy rich on a single hot stock.

During times of market volatility, it’s even more important to ensure that the level of diversification in your portfolio aligns with your risk tolerance. Ask yourself: is your portfolio overweight (say, more than 10% of overall value) in any one company, one sector or one market? Would a 20% decline in that overweight holding put a significant dent in the overall value of your portfolio, or force you to change your retirement lifestyle?

No? Then by all means, continue with your more concentrated strategy − you may well be handsomely rewarded for it. But if you answered yes, then now is a good time to protect yourself by trimming back and spreading those eggs among several different baskets: different companies, different sectors and different geographic markets.

6. Add some new income…

One of the best solutions to bear market anxiety: money coming in the door. In addition to its obvious benefits in terms of your ability to pay the bills, a source of steady, reliable income can have a very important psychologically calming effect during difficult times.

If you have the ability to develop another source of income, do it now. Perhaps you can work part time, or do some freelancing, consulting or a small contract job every now and again. Maybe you can “monetize” your hobby by selling your creations online. Or maybe you can get into the rental game, either by purchasing a rental property or renting out your home, your basement, or even a single room for short-term stays.

Of course, not every snowbird is interested in any of this stuff − for some of us, retirement means getting as far away from work as possible. And that’s OK. But if you find yourself fretting about your finances during these times of turmoil, it’s worth taking a look to see if you can bring in a little “extra.” Even if it’s only a couple of hundred bucks a month, you’d be surprised how that little extra can make a big difference to your peace of mind.

7. …while taking care of the income that you already have

Over the past decade, many retirees have come to realize the benefits of having a rental property in their retirement portfolio. The regular income that’s (mostly) independent of market movements can be a rock-solid financial foundation to cover baseline expenses, while providing significant peace of mind, too.

But ask any landlord: you can’t play “set it and forget it” with a rental property like you sometimes can with a stock portfolio. That goes double in times like these, when that steady rent cheque is responsible for your financial stability and peace of mind.

Take some time now to check in on your income property: make sure that your tenant is happy and that everything continues to work smoothly for them. If you have the opportunity to make a low-cost upgrade (a new appliance, for example) or a simple renovation (a new coat of paint) that helps to secure your relationship, it’s probably a good investment to make. Take care of your income stream by investing the time, effort and attention needed to keep that income coming in the door.

8. Sweep up the dirt

Veteran investors know that not every investment works out the way they want it to. Here’s another thing that they know: how difficult it can be to admit. It’s tough, knowing that despite all of our effort, knowledge and skill, we made an investment mistake. And so, we hold on to positions in the hopes that they will come back − even though the money may be put to much better use in a different opportunity.

Now that we’re in a bear market, the time has come to sweep up the “dirt” that’s accumulated in your portfolio by selling losing positions. Depending on your individual circumstances, such a move may generate tax savings; generally speaking, investors can claim capital losses to offset taxes owed on any gains made up to three years ago. (Please make sure to check with a qualified accountant to ensure that such a strategy makes sense for you − it depends on your personal financial situation.)

In a bear market, sweeping up the dirt has another benefit: it frees up cash that you can reallocate to opportunities created by the bear market. It’s a classic “buy low, sell high” strategy, and one of the best ways to take advantage of the cross-the-board turmoil that often leaves high-quality companies on sale. Yes, it’s tough psychologically. But financially, it’s often a winning strategy.

9. Do a “debt disaster check”

To state the blindingly obvious: debt can be a very useful (but very dangerous) financial tool. That’s true anytime. But during times of rapidly rising interest rates, when the economy is teetering on the edge of recession and the market is increasingly volatile, debt can be a downright disaster.

To protect yourself, make it a priority to do a “debt disaster check.” Take a close look at the debt you hold, and assess your ability to service it if rates go up − and keep going up. You’ll want to ensure that even if worst comes to worst − if interest rates double, triple or even quadruple − you’ll still be able to pay at least the interest without downgrading your retirement.

For some snowbirds, debt isn’t much of a concern: their mortgage is locked in for several years (or maybe paid off entirely), they purchased their vehicle with cash, they usually pay off their credit cards every month, and so on. For others, who hold mortgages on a principal residence or on a rental property, or have an outstanding loan for their car or their business, or have taken out a home equity line of credit to fund their lifestyle, it’s something to keep an eye on.

10. Quality, quality, quality

Remember the old saying about the three most important factors when buying real estate: location, location, location? Well, if you’re a stock investor, the three most important factors to keep in mind when investing during a bear market are: quality, quality, quality.

If you haven’t already done so, it makes sense to “tilt” your portfolio to quality names: well-established, blue-chip, dividend-paying companies that are known to have sustainable competitive advantages. If you’re a fixed-income investor, stick to quality issuers such as developed-world governments and investment-grade credits from the corporate world. No, this won’t eliminate all volatility, but it will make your portfolio a lot more resilient to the whipsaw back-and-forth action of most bear markets.

This is not to say that you shouldn’t speculate at all. But if you do, do it with your eyes wide open: recognize that in bear markets, speculative, high-risk/high-return opportunities often suffer the most. If you’re a veteran investor with a sizeable portfolio and a strong stomach for risk, then by all means go ahead and speculate. But for most of us, it’s probably best to stick to quality and take a pass on the wild bets until things settle down.

11. Start thinking “opportunity”

We’ve said it before and we’ll say it again: behind every bear market there’s a silver lining: the share prices of great businesses often go on sale. If you’re a long-term investor with a bit of tolerance for volatility who can learn to identify these “bargains” (or work with professionals who can), then a bear market can actually be a very good thing.

If you haven’t already done so, start getting a watch list of quality opportunities which you’d like to own, should their shares go on sale in the near future. Ask yourself: what part of the market is being sold off indiscriminately? What stocks or sectors have been out of favour during the bear market? What excellent investments can you “stock up on” and then wait to rebound?

Truth be told, this type of contrarian thinking − that the time to be thinking opportunity is when everyone else is thinking crisis − has been a feature of most of the successful investment minds in the world. And it should be for yours as well.

12. Feeling stuck? Seek out a professional opinion

Anxious about what a declining stock market means for your retirement? Wondering whether you’re pursuing the right financial strategy? Still waking up at night (figuratively or literally) worried about your portfolio? Feeling “stuck” about what to do (or not do) about the bear market? Sounds as if you need to talk to a professional.

A qualified, experienced wealth advisor or financial planner can help review your current portfolio and your long-term investment strategy to ensure that you’re on the right track. Perhaps more important, an advisor can function as that calm, objective source of reason during times when market turmoil turns into emotional turmoil. And, when we emerge from the current bear market (as we eventually will), an advisor can ensure that you’re well-positioned to take advantage of emerging opportunities and new trends. All in all, sounds like a pretty good plan.

by James Dolan