INSIGHTS

On July 31, 2017

Are You Prepared for the Bear? - A Redux...

About three years ago (8/22/2014) we penned the piece, Are You Prepared for the Bear?  To be clear, we weren’t calling for the beginning of a new bear market for equities then, actually quite the contrary.  Fast forward to today and we aren’t calling for one now either as we believe it is a fruitless game, but clearly we are getting closer every day.  We feel investors need to recognize this and ensure they are adequately prepared when the bear does arrive.  However, before we talk about those strategies, let’s take a closer look at this almost-record bull market run. 

With the S&P 500’s new record high of 2477.83 on 7/26/17 this bull market run is now 8.4 years old and the S&P 500 has now experienced a cumulative total return of 337% (3/9/09 – 7/26/17).  Pretty impressive, but somewhat humble when compared to small-cap’s (S&P 600) move of 431% over the same period.  These outsized total returns alone are causing some investors to question the viability that this bull market can continue.  Given this we would like to note the trailing 10-year annualized total return (6/30/07 – 6/30/17) for the S&P 500 is 7.2% which is well below the 70-year average of 11.2%.  So yes, the equity markets have come a long way since March of 2009 but the returns pale when compared to the long-term averages. 

That’s an important term – long-term.  When we look at the data for the last 70 years it shows that investors that invested in the S&P 500 for a period of 10-years experienced a positive return 97.2% of the time, doubled their money 76.1% of the time and had an annualized return (as mentioned above) of 11.2%.  When we shorten this to 5 years those numbers are, respectively, 90.8%, 71.1% and 11.2%.  The probabilities fall slightly but the annualized return stays the same. Given this we think it is both prudent and justified for long-term equity investors to use a minimum time horizon of 5-years when investing.  It also lines up somewhat nicely with the average bull/bear cycle which averages 4.4 years for a bull and 1.2 years for a bear for a total of 5.6 years. 

The question then becomes, can we accurately predict the beginning and ends of bull and bear cycles?  We don’t believe investors, strategists and prognosticators can, but that doesn’t stop them from trying.  This current bull market’s end has been called more times than we care to count, including this week which saw the S&P 500 hit a new all-time high on Wednesday followed by a sharp reversal on Thursday.  Yes, this could be the beginning of the end for this bull, but we don’t think so.  Even more importantly we don’t think longer-term equity investors (greater than 5-year horizon) should focus on these inflection points that are hotly contested and predicted in all forms of the media.  Instead they should focus on, as we have discussed before, preparing themselves mentally and physically (through proper allocation and investment strategy) for these inevitable setbacks as opposed to trying to time the market.

What does it mean to be properly allocated?  In a nutshell, it is different for every investor depending on their goals and risk tolerances, but we believe it begins by diversifying by size or market capitalization.  As an example, one of the worst times to buy stocks would have been the S&P 500’s peak on 3/24/10.  The S&P 500 Index had a negative return over the subsequent five years of -17.1% (3/24/00 – 3/24/10).  However, over that same period mid-cap stocks (S&P 400) garnered a positive total return of 39.1% and small-cap stocks (S&P 600) fared even better at 52.7%.  We can then extend that to style.  We see the S&P 500 Value Index also posted a positive total return over that period clocking in at 8.6% and if we make one more extension across borders we show the MSCI Emerging Market Index had a total return of 19.6%.  Clearly this five-year period was tough for the S&P 500, but equity investors who diversified their equity holdings would have fared much better.

In addition, we think equity investors would be well served to also diversify across asset classes. Over this five-year period (3/24/00 – 3/24/05) bonds (as measured by the Bloomberg Barclays U.S. Aggregate Bond Index) had a total return of 41.4%, real estate investment trusts or REITs (as measured by the MSCI US Real Estate Investment Trust Index) had a total return of 141.9% and master limited partnerships or MLPs (as measured by the Alerian MLP Index) had a total return of 163.6%.  Clearly past performance is no indicator of future results but history has shown time and time again that diversification has provided very good ballast for equity investors during market selloffs and we believe that will continue to be the case going forward.  In closing, as markets hit new highs we think investors would be better served focusing their efforts on rebalancing and reallocating instead of outright selling and contemplating if this is the beginning of the end for this current bull run.

Source for index returns: Bloomberg

CRN: 2017-0710-6032 R

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures.

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