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Bear Markets: A Trap for the Hopeful

Bear Markets: A Trap for the Hopeful

| September 14, 2022
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       A bear market is defined as an extended period of price declines in the stock market. Textbooks will not give you an exact numerical measure for identifying a bear market, but we consider a 20% decline in overall stock market condition to be the arbitrary number that signals a bear market; that is a 20% drop from the most recent high. Colloquially, I explain this to my clients in this manner: a bear market is characterized by lows, followed by lower lows, with highs that do not reach the previous high. Let us put some numerical values to that. 

       On Monday, January 3rd, 2022, the S&P 500 reached an all-time high when the index closed at 4,796.56. As of September 13, 2022, (the time I’m writing this) the index has not reached that previous high again, and closed at 3,932.69, reflecting a Year-To-Date return of -18.01%. The chart below graphs the sequence in a more digestible manner.   

     

       To put this into perspective, March 23rd, 2020 was the lowest point of the S&P 500, early pandemic days, when the index closed at 2,304.92. As you can see, even with these seemingly steep swings, we're still about 1,600 points higher since then. Now, while these numbers are not necessary alarming yet, contrary to what you might think, by no means do I want to suggest that there's no need to be cautious, nor than there's no need to be in alert given the economic conditions we have been given.

       Because this degree of index volatility, along with FED Reserve chair Powell’s most recent remarks on continued discount rate increases, signals a high probability of a continued bear market condition. And typically, investors have a very small window to be proactive and make adjustments. Things change rapidly in the stock market and people naturally suffer of another impactful pandemic called FOMO, which is short for Fear OF Missing Out. I'm not judging, this is a trick of the mind.

       People also forget that economic policy doesn’t keep pace with market shifts. The Federal Reserve has a historical trend of working slowly. We could discuss in a future reading how they created these market conditions, but the fact is interest rate monetary policy is a reactionary measure, not anticipatory. Therefore, while I believe the FED is taking the correct necessary measures to slow down the unprecedented speed of growth, it might just be too little and too late. They may not be able to contain this one. They may not even be able to “soften the blow”. 

       Let’s go back to what makes bear markets a trap for the hopeful. There’s a reason I purposely drew the red line on the chart; this is something we do on a normal trading day. We use it as a ruler function to visualize the decline. When you don’t do this, you can be fooled by the short-lived bounce backs, and fall into the “bear market trap” in hopes of an end to ongoing decline in prices. It seems an obvious thing to avoid, but in practice it’s very easy to miss if you’re not trained in technical analysis and charting. I personally call that “tuning out noise”, because the temporary rallies are typically the result of complete “street” speculation and commotion created surrounding that time. It could be a news article reflecting on the opinion of economists, news of potential global conflict or the resolution of, or even conspiracy theories. Whatever the case may be, short-term rallies are usually the result of noise that gained massive popularity and doesn't affect stock market pricing in a fundamental way over the long run. 

       We are hopeful individuals in nature. When it comes to money, our nervous system functions at its best when surrounded by positivism. Unless we train ourselves through education and knowledge, we can’t avoid panic in times of turmoil. Emily Bouchard, a wealth coach at a private capital firm, explained in a U.S. News article that it's harder for people to make rational decisions about investment strategy during bear markets. She went further listing the most common emotional reactions such as: herding behavior, recency bias and knee-jerk reactions. And she also explains how to regain control. All of these are typical behavior of panicked individuals. I’ll put a link to that article at the end of this reading, if you would like more insight on behavioral finance

       While I don’t have the right to tell you not to panic, I have the knowledge and training to tell you there’s no need to panic. While these are economic and politically concerning times for all, as a firm we have been preparing for elevated levels of volatility and a big market crash for a very long time. The biggest flaw to the Federal Reserve Board of today is how they’re always taking measures after the fact. For instance, in the 1990s, they incentivized controlling government budget deficit only after the recession of the 1980s, it was painful, but FED Chair Paul Volcker succeeded. Now they’re increasing interest rates only after inflation has gotten out of their control and in the middle of a recession.

       What sets us apart from other firms is our constant discussion over exercising caution and preparing for unprecedented times. We knew this was comingNot because we have a crystal ball that reveals future events, but because word on the street is “history doesn’t repeat itself, but it rhymes”. We've been long due for a cycle shift. Like renowned hedge fund manager Ray Dalio explained in his book Principles for Dealing with the Changing World Order, these cycles happened in the past, all over the world, and the only reason we may not recognize them immediately is because they haven’t happened in our lifetime. None of you reading this lived through the Roaring 20s era. Almost all of you read about The Great Depression, but you didn’t experience it. Most of you remember that there were high interest rates in the 1980s, but you were starting to or in the middle of saving for the future, which means you probably can’t exactly identify if inflation impacted you in a substantial way. Therefore, what you remember most vividly is what happened in the last 20-25 years.  

       If you remain cautious and in pursuit of financial knowledge, there’s a high probability the current economic pressures will not be financially (and emotionally) devastating for you or your loved ones, as you will be better prepared and more conscious of what is going on. If you fall for bear market traps, chase after short-lived market returns, listen to the noise and react to it, I’m not sure what the outcome will be. I don’t think it can be good though. 

       By the way, if you haven’t read Ray Dalio’s book that I mentioned above, I highly recommend you get either a physical copy or listen to it through Audible. You gain great insight into economic cycles throughout our history. 

 

Article Link: How to Invest in a Bear Market According to a Behavioral Analyst´╗┐

 

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