The bull market celebrated its sixth birthday party on March 9, making this the fourth longest month-by-month ascent on record. Since that dreary day back in 2009, the S&P 500 index is up 200 percent, and the carnage of the 2008 bear market is slowly fading from memory.
That’s the good news. The bad news is that this current stock market is likely overvalued and long overdue for a nasty decline, if not another grinding bear market.
What will trip up the bull? All signs point to a strengthening global economy and solid employment gains, which are tempting the Federal Reserve to ratchet up interest rates, thus pushing down the stock market.
Should you be concerned? Not if you have created a smart portfolio allocation between stocks and bonds that reflects the reality of periodic bear markets. Here are some points to ponder to see you through the next bear market, and the next one, and the one after that.
Instead of trying to predict the next bear market (generally identified by a 20 percent decline) with your investment decisions, a better approach is to acknowledge that bear markets are inevitable. Whether the next bear market unfolds two months or two years from now, there will be another bear market.
If you are 50 years old, odds are good you’ll experience six more in your lifetime. Although it is never fun to watch portfolios decline, these sell-offs are integral to the flow of capital around the world. Furthermore, constructive bear-market investors can generate improved portfolio returns over time by purchasing more shares at lower prices.
The essential step to embracing bear markets is to quit looking at your portfolio balance every day, every week, or every month. Try once a year. Behavioral scientists long ago identified myopic loss aversion, the negative behavior associated with reviewing portfolios on a frequent basis. Investors are more sensitive to losses than they are to investment gains, which leads them to sell holdings prematurely in an attempt to stem the emotional pain of a temporary financial loss.
You can bail out of your stock-market investments, as many investors do during steep market declines, or use these declines as an opportunity to purchase more shares at lower prices, through monthly portfolio contributions or timely rebalancing from bonds to stocks.
This is serious stuff, because if history is any guide to market performance, we are in for a long rough stretch of market volatility and steep declines. Not only is the stock market overvalued, but research by J.P. Morgan shows that the sustained returns of the past few years are anomalous. Although the S&P 500 has generated positive calendar-year returns in 27 of the past 35 years, its average intra-year (peak to trough) decline was a gut-wrenching 14.2 percent.
A 14 percent dip can be hard to ride out, but if you stay committed to your portfolio allocation, rebalancing when necessary, you are likely to generate decent investment returns over the next 10 years and beyond. This is predicated not on selling your common stock positions during market declines, but on having the perseverance to use these inevitable sell-offs to purchase additional shares at lower prices.
In the midst of a six-year bull market, it is easy to talk about staying the course in the next bear market. It is a far greater challenge to stay the course when the market is actually down 25 percent and the financial media are forecasting the end of the world, as they did in 2008.
For now, here’s to another year of the long-running bull.