Keeping You Informed Process Versus Prediction During a Bear Market (Part I)

Release Date - March 27, 2020

While it is always tempting to try to time the market and wait for the bottom to be reached (as if it would be obvious when it arrived), such a strategy has proven over the years to be deeply flawed. Historically, little volume transacts at the bottom or on the way back up and competition from other buyers will be much greater when the markets settle down and the economy begins to recover. Moreover, the price recovery from the bottom can be very swift. Therefore, an investor should put money to work amidst the throes of a bear market, appreciating that things will likely get worse before they get better.

— Seth Klarman (famous manager of The )

Investors have a few choices when stocks are in the throes of a decline: 1. Sell stocks and get back in later, either when prices are lower or when things “settle down” 2. Hold onto their positions (buy and hold) 3. Rebalance to your long-term target 4. Buy stocks over a course of months to reach a higher stock allocation target (Example: If you had a 50% target, now you work towards a 60% target)

Of course, EVERYONE wants #1. They want to be told what will happen, when it will happen, and execute accordingly. Sell now, avoid the pain, buy later at the bottom, and ride it higher. Or, sell now, avoid the pain, and buy back in when the “dust settles.” Oh, if it were only that easy!

One of my favorite charts (below) shows Isaac Newton’s struggle with investing in one of the first bubbles ever – South Sea Company stock. After his greed and fear market timing exercise failed, he famously said, “I can calculate the motions of the heavenly bodies, but not the madness of people.”

Source: Marc Faber, Editor and Publisher of “The Gloom, Boom & Doom Report.” https://www.businessinsider.in/isaac-newtons-night- mare-charted-by-marc-faber/articleshow/21205903.cms

8444 Westpark Drive, Suite 610, McLean, Virginia 22102 | Tel: 703.734.9300 | Fax: 703.288.1650 | Website: www.sbsbllc.com Indeed, people have been trying to figure out the best way to investfor centuries. This is nothing new. And yet, after all these years, one of the most common adages in investing is, “You can’t time the market.” That saying wasn’t made up with- out discernable reason – it was the culmination of centuries worth of testing.

But why?

Well, let’s take Tuesday, March 24, 2020. Practically every stock index I saw on my screen closed the day with an approxi- mate gain of 9%. While there were hopes of a fiscal stimulus package, there was also some horrible news with respect ot the economy and spread of coronavirus. Here’s a taste of the headlines that day. Notice the choice of words (emphasis added) implying we’re only at the beginning of things getting bad.

“Market U.S. PMI report [manufacturing index] signals the ‘steepest downturn since 2009 in March’” — Yahoo! Finance

“Surge in Unemployment Claims Sparks Delayed Checks Amid Coronavirus Crisis” — Journal

“Downgrades Begin Amid Economy’s Freeze” — Wall Street Journal

“Potential wave of mortgage delinquencies could bankrupt the payment system” — CNBC.com

“United States could become Coronavirus epicenter: WHO” —

Despite those headlines, the rally continued Wednesday despite the previous day’s spike and knowledge that the dreaded unemployment claims figure was coming out the next morning. The expectations were for a record 1.5 million claims for the week, exceeding the peak of 665,000 at the worst of the Global Financial Crisis in March 2009. Claims came out much higher than expected at 3.28 million, yet the market extended the rally on Thursday by another 6%!1

Why? I believe it was due either to the fact (a) that 3.28 million was lower than some of the “whisper” numbers some thought (4-5 million), or (b) that it was bad enough to warrant more stimulus from the government, which the market loves. The main point here is that the markets are generally driven by investor psychology and emotions, which cannot be consistently analyzed or predicted. Combine that with huge daily swings, and timing mistakes become very costly.

Source: YCharts. Date range is for the weeks ending January 7, 1967 – March 21, 2020.

8444 Westpark Drive, Suite 610, McLean, Virginia 22102 | Tel: 703.734.9300 | Fax: 703.288.1650 | Website: www.sbsbllc.com Another challenge of market timing is that the market often moves higher well before both the economic and corporate data gets better. This can be seen in the following chart that illustrates how the market bottoms, on average, four months prior to the end of the recession, and also recovers all the decline of the previous year before the recession ends. Notice the near vertical slope of the initial recovery.

Source: Copyright 2020 Ned Davis Research, Inc. Used with permission. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo/ .

As if this wasn’t enough, I forgot to mention the behavioral mistakes that one could make with the flood of potential thoughts that can race through your mind when the market zooms up from the bottom.

“I’m sure this is a dead cat bounce.”

“Maybe I should sell more in case it turns back over.”

“This can’t be the start of a bull market, can it? Can’t people see that things are getting worse?”

“OK. Maybe the market is right. I’ll just wait for a small pullback and then I’ll start buying.”

“Oh man, did I just miss the buying opportunity of the decade?”

“What if I buy now and then there’s a double-dip recession? What if the virus comes back in the fall?”

In the end, investing is about adhering to a process that has the best chance of working over the course of your life. It’s simply a probabilities game, and I hope I’ve shown why a strategy based on market timing may work occasionally but is destined to fail over time. There’s a reason why “the house always wins” in Las Vegas.

In Part II of my commentary, I plan to go into more depth about other ways investors can approach a bear market.

I hope you, your family, and friends continue to have good health and are coping well during this challenging time. As always, please reach out to us with any questions, or if you want to talk about your financial plan and portfolio. We’re here for you, and we want to hear from you.

Jeff Porter, CFA®, CFP® Principal, Chief Investment Officer

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