Deep Dive
Shownotes Transcript
As a long-term investor, you need long-term insights. Use AssetCamp to look past speculative market hype and understand past performance, current trends, and model expected returns for stock and bond indexes. Markets move in cycles. Don't miss what's next. Get a seven-day free trial at AssetCamp.com. That's A-S-S-E-T-C-A-M-P dot com.
Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I'm your host, David Stein. Today's episode 391. It's titled, How to Survive a Bear Market.
A bear market is a stock market decline greater than 20%. The Vanguard Total World Stock Market ETF, VT, has returned negative 21% year-to-date. The S&P 500 Index, a measure of U.S. stocks, has returned negative 22% year-to-date.
This is the eighth bear market for global stocks since 1987. They occur about every three years on average, although our previous one was only two years ago, back in 2020. Bear markets have lasted about one year on average, with an average decline of 30%, as measured by the Dow Jones Industrial Average going back to 1901.
I have lived as a professional investor and then subsequently, I guess, as a professional podcaster through five bear markets. The first that I remember as an investment advisor was the 2000 to 2002 bear market. This was the internet stock market bubble and crash and growth stocks sold off significantly also. But I remember this bear market because value stocks had...
held up much better and most of our clients by then had rebalanced at least back to value if not had a value tilt. Other asset classes like equity REITs did well during that bear market and we survived.
The 2007 to early 2009 bear market was much, much worse. Everything sold off, both growth and value. We saw 60% declines for stocks. It felt awful. Most of my personal wealth at that time, at least my publicly traded portfolio, was in cash. That's not something I do anymore. But at the time, it was easier to do because I had less wealth.
And I had seen the debt bubble, the housing bubble, and I took a big risk and moved everything to cash and it worked out. I had no idea it would be that severe. Most of our clients that had diversified portfolios, their portfolios sold off overall around 25% for that bear market. But then they did incredibly well as we positioned for the recovery.
The 2011 bear market was for global stocks, but the U.S. didn't actually reach an official bear market level. But it was short, only about five months. But those five months felt bad. And it was during those five months that I decided to leave the investment business. I was just tired of managing assets and the risk of navigating bear markets and bull markets.
The 2020 bear market, consider that. The U.S. went 11 years without a bear market. Incredibly long period of time. On average, bear markets occur every two to three years. This time, it went 11 years. And for the global stock market, it was nine years.
This bear market was due to the pandemic shutting the economy down, but it was extremely short because central banks and governments were incredibly aggressive in cutting interest rates, doing quantitative easing, providing stimulus, buying assets such as corporate bonds to provide liquidity and backstop some of these losses. Those programs by governments and
And central banks led to a large increase in liquidity, in cash, in net worth, and inflation. And we discussed that a couple of episodes ago when we discussed quantitative tightening. That set the stage for inflation. Something that we have discussed was coming, how to prepare for it, and it's here. The highest levels of inflation since the early 1980s.
So now we have a brand new bear market, high inflation, and again, aggressive central bank action, but in the opposite direction this time, trying to slow the economy because the inflation we have was because of excess demand and not enough supply of goods and services coupled with ample liquidity. Now central banks are
are trying to raise rates to slow the economy, avoid a recession, reduce demand, and hopefully orchestrate what's known as a soft landing, where the economy slows enough to reduce inflation, but without falling into an economic contraction.
This bear market is similar to the 2000 bear market in that the most speculative assets have sold off the most. The Nasdaq 100 has declined 33% since its high last November. Bitcoin has fallen over 70%. The ARKK, which invests in high-growth, more speculative companies, is down 60% year-to-date.
Value investing has held up relatively well in this downturn. The iShares Edge MSCI International Value Factor ETF, this is a non-US ETF that is invested in value stocks. It's one of the holdings in the Money for the Rest of Us model portfolio examples. It's down only 16% since last November. This bear market is different from any bear market since the early 1980s.
in that it's being driven by higher interest rates. And that is leading to big losses in the bond market. The Vanguard Total Bond Market ETF, BND, is down 11% year-to-date, while longer-term bonds, as represented by the iShares 20-plus-year Treasury Bond ETF, TLT, is down 20% year-to-date. That has made for a challenging investment environment for investors using role-based portfolios.
such as the permanent portfolio or the all-seasons portfolio. These portfolios have assets divided between stocks, longer-term bonds, gold, and other assets that are expected to have gains and losses that offset each other depending on the environment. There's a portion in stocks that perform better during periods of economic growth. There's an investment in long-term bonds and cash that tend to perform better during recessionary periods.
There's holdings of gold and commodities that tend to do better during periods of higher inflation. And then during periods of deflation, the portfolio also holds the long-term bonds and cash.
But if we look at how those portfolios have performed, and we have on Money for the Restless Plus, we have sample portfolios that track those different role-based portfolios with sample ETFs to implement those strategies. So we can track the performance of those model permanent portfolios, and they're down between 11% and 20% year-to-date, depending on the structure.
Other interest rate-sensitive assets have also declined. Equity REITs have declined over 20% year-to-date after returning over 30% last year. Preferred stocks have declined 17%. There's really been nowhere to hide during this bear market except for cash and commodity futures, which are up 37% year-to-date. We discussed commodity futures in depth back in April in episode 384.
Here's the thing, though, in surviving bear markets. There are two unknowns. Well, there are many unknowns, but two principal unknowns I want to focus on here. One, we don't know if we're headed into a recession or not because we do not know how high interest rates will go.
The Federal Reserve might need to raise its Fed funds rate, its policy rate, which it just raised 0.75% last week. It could go as high as 3% to 4%.
That could reduce demand. Well, it will reduce demand, but will it be enough to send the U.S. economy and the global economy into a recession? That will clearly hurt corporate profits, and we could see greater losses for the stock market. During recessions in bear markets, the average loss has generally been over 40%. So we don't know how economic trends will play out, nor do central bankers.
They don't know what it will take to reduce inflation. We do know that their reputations are at risk, and so they will do what it takes to bring inflation down. What we also don't know is the level of pessimism. We have anecdotal evidence to show that investors are incredibly pessimistic. They expect a recession. They are worried about further stock market declines. They have sold assets. When investors get too pessimistic,
When things turn out to not be as bad as they thought, when there's positive surprises, then we can see a rebound in assets. That's why I have a difficult time to move all of my net worth to cash.
Because I want to continue to generate compounded returns. Now, maybe we make adjustments and we'll discuss that. But there's the risk that the pessimism is so great that when we get a more positive inflation report, that risk assets rebound quickly.
I was absolutely shocked how quickly we rebounded from the 2020 bear market due to that unprecedented influx of cash and stimulus and Federal Reserve and other central bank actions to buy up assets. A two-month bear market, three months. So we don't know. What do we do then? How do we survive a bear market?
The first thing we do is understand our exposure. Rather than trying to predict what's going to happen, we want to make sure we survive the bear market. And to do that, we need to know what our exposure is. What do we own in our portfolio? Will our lifestyle be harmed?
Our retirement would be harmed if stocks continue to fall to where we see the 50% or 60% type declines that we saw in the 2007 to 2009 period. I've done this in the last couple of weeks. Once we saw the May inflation report for the U.S. came in, it was not a good report.
There was inflation up and down the various categories, led by energy and food, but also core, rents, owner's equivalent rent. That continues to increase, something we've also talked about, the potential of happening. That resulted in the Fed raising their policy rate three quarters of a percent. We saw the stock market sell off over 6% last week.
It's declined, I believe, 10 out of the last 11 weeks. And so I reviewed my portfolio. I wanted to know, are there assets I'm uncomfortable holding given current conditions? I've made seven portfolio trades this year, five to reduce risk. Now, I trade more frequently than most individual investors.
We don't make nearly as many changes to our model portfolio examples that I do in my portfolio because I like investing. But I reduced my exposure to Ether, Ethereum in February because my exposure was too high. I was not comfortable with the amount of exposure I had. It was 3% of my net worth. So I cut it in half and the markets cut it even lower due to the tremendous sell-off in Ethereum. 70% type declines, I believe, since November.
I closed my BlockFi cryptocurrency interest account in May because I didn't know what the exposure was there because I couldn't see what was in their portfolio on their balance sheet. I didn't know what the risk was.
But I felt the risk was increasing that they could see higher defaults on their loans given the tremendous sell-off in the crypto space. And we saw that one of their competitors, Celsius Network, that also does cryptocurrency lending, they suspended withdrawals last week. Clients can't get their money. That was my worry with BlockFi. BlockFi hasn't suspended withdrawals.
But it was a risk and it was exposure I wasn't comfortable having given the environment. I reduced my equity REIT and preferred stock exposure in January because of rising interest rate pressures. We did that also in the model portfolio examples. But I also made two changes to increase some risk. I added two non-investment grade closed-end funds. One's a private debt fund
the Barings Corporate Investors Fund, tickers MCI, and the BlackRock Debt Strategies Fund, DSU. This is a bank loan fund. Combined, they represent about 2.5% of my net worth. I made those trades in March and April. I was early, perhaps premature.
Thinking that I didn't know if a recession was coming when it would come, I typically don't like to have much non-investment grade debt exposure entering into a recession. But because these are closed-end funds, their discount to their underlying value, the net asset value, had widened meaningfully. I added some exposure because the distribution yield was attractive. Now they've sold off.
It doesn't feel very good, but that's part of investing. And helping you understand how to invest in closed-end funds is one reason we launched a course last week on closed-end fund investing, which you can check out at moneyfortherestofus.com slash CEF. Before we continue, let me pause and share some words from this week's sponsors.
As many of you know, I used to be an institutional investment advisor. I advised clients like the Texas A&M University System, the Sierra Club Foundation, and others strategizing investments across billions of dollars. To help, I had access to top-tier tools and information, which was crucial for making smart investment decisions.
Since starting this podcast, however, I've been frustrated that the same tools I relied on aren't available to you, even though personal investing requires just as much thought and trust as institutional investing, maybe even more since it's your own money. That's why I created AssetCamp. AssetCamp's tools and insights puts you at the forefront of investing, allowing you to make informed decisions using stock and bond data that was once only available to institutional insiders for tens of thousands of dollars per year.
Asset Camp is not a stock picking tool. It's
asset-focused research built on the same methods used to grow and manage leading endowments and investment funds worldwide. AssetCamp helps you easily understand what drove past returns for the stock and bond markets, laying the foundation for your next move. With AssetCamp's powerful charts and tables, you can easily identify potential opportunities and risks. You can also confidently navigate the future by modeling expected stock and bond market returns and stress testing all your decisions.
AssetCamp also teaches you expert investing tactics in a monthly user webinar, including an open Q&A portion where I answer your investing questions. I invite you to try AssetCamp free for seven days at AssetCamp.com. That's seven days free access to the world's only asset-focused research tool built specifically for individuals like us. Try it free at AssetCamp.com.
As I went through my portfolio, looking at my exposures, I realized I can survive a bear market if markets sell off 50 to 60%. I'll be okay.
My lifestyle won't be impacted. My portfolio is broadly diversified. My overall common equity exposure is only 13% of my net worth. I have another 12% or 13% in income strategies, such as preferred stock and equity REITs. Those are riskier assets, but I also have private assets that tend to hold up better during down markets. I can survive a bear market. The average bear market lasts a year. Maybe it lasts two to three years.
I'm only partially dependent on that investment portfolio to live on. That might not be your case. If you're very dependent on that portfolio, on your portfolio, you want to make sure that your lifestyle will not be impacted by significant declines. And if it will, then it's okay to reduce risk, not knowing how it will play out.
So that's the first thing we do. Understand our exposure. Don't focus on prediction. Focus on managing your exposure.
The second thing we can do is see if we have dry powder to take advantage of opportunities. It's okay to have some cash, some more conservative assets that could be sold when the environment changes. Now, if you're still working, you do this naturally because you can dollar cost average as you earn income and move it into your investments.
Perhaps you have some cash. And maybe we raise additional cash if a risk of a recession increases. One of the things that we're doing in Money for the Restless Plus that I'm very focused on is leading economic indicators.
such as purchasing manager indices. Those flash reports that market releases this week, late this week, I'm very focused on to see if the risk of recession is increasing. Because right now, as we went through our June investment conditions report, there was insufficient evidence to suggest a recession was imminent, was coming, that we should reduce risk based on recession risk.
So we'll look to see. One of the other leading economic indicators that we consider is the Conference Board Leading Economic Index. This is made up of 10 variables, such as housing construction, consumer sentiment, stock market, interest rates. It fell in May. It was just released a few days ago. It decreased 0.4%, down to 118%. So it's still elevated near a historic high, 0.4%.
But it suggests weaker economic activity. One of the metrics I look at is the six-month rate of change. Generally speaking, the U.S. has entered into a recession when the six-month rate of change of that leading index, it falls by more than 2%. The six-month rate of change we've seen now is down 0.4%.
The other element is, are more than 80% of those components, so 8 of the 10, are they lower than six months prior? Now we have 60% are lower than six months ago. Clearly, recession risk are higher based on that, but we're looking for a decline greater than 2% compared to six months ago and 80% of those underlying components. We monitor that monthly at Money for the Rest of Us+.
The benefit of having some dry powder, which can be cash, but it can be other assets that we have some protection, short-term bonds, for example, that we can move into more attractive opportunities.
This past week, we've been working on our updated expected return assumptions for stocks, bonds, and other asset classes. The last time we did this update was in November. Things have changed. Six months ago, our long-term expectations for stocks was 6%. Now it's 6.9%. We use a building blocks approach, looking at dividend yields.
looking at earnings growth and looking at change in valuations. As part of this analysis, we get historical earnings for stock market indices from all over the world. And we wanted to make sure our methodology actually works. So we looked at the returns over the past 20 years, the returns for the global stock market, for the U.S. stock market. And then we looked at those three building blocks. What was the dividend yield over that time?
What was the earnings growth over the past two decades? And what was the impact of valuation change? And what we found is that methodology, if we use those three components and combine them, that the returns based on those estimates was very close to that actual annualized return for those different indices. So it gave us even more confidence in our approach.
And then we have ranges around that because we can use those three elements and say, oh, well, what if price to earnings ratios fall over the next two decades? And what if earnings growth is less than our baseline assumption? What would the lower range of returns be? We do the same thing for more positive because it isn't a point estimate that matters. It's what's the range?
And that allows us to model different portfolio mixes based on that. The other element we saw then from six months ago is the dividend yield today is 2.1% compared to 1.7% six months ago. And the PE, the price to earnings ratio of stocks as of the end of May was 17.7. It's going to be a little lower now compared to 22.7 back in November. So combined, that gives us a higher expected return.
Interest rates are higher. So we can assume higher returns for bonds because the best estimate of bond returns is the current yield to maturity. A year ago, back in November, the yield for global bonds was 1.2% and for U.S. bonds, 1.5%. That was the expected return over the long term. Now, the long-term expected return for bonds based on current yield to maturities is 3% and 3.2% for U.S. bonds.
Non-investment grade high yield bonds, we're looking at a long term expected return of five and a half percent compared to one and a half percent back in November. That's how much interest rates have increased for high yield bonds. And the higher the interest rates for bonds, the more cushion there is a buffer for potential defaults.
We've also seen higher expected returns, long-term for equity REITs, preferred stock, convertible bonds, and many other asset classes. And we share those, again, on Money for the Rest of Plus. And we'll spend a lot of time in this weekend's Plus episode talking about the changes and what drove them. The point is, though, when assets...
asset classes sell off in the bear market, it means future returns will be higher because now you're buying in at a more attractive price. Bear markets give us an opportunity to reposition our portfolio once the coast is clear, when the recession risk has dropped, perhaps when the central banks have stopped raising their policy rate, when investors become less pessimistic. We can position for that incrementally.
With these higher interest rates, it gives near retirees and retirees an opportunity to enter into annuities. I saw that fixed annuities, I saw one five-year fixed annuity, 5.5%. Now we can get a fixed annuity where you get the money back after five years. Those rates are more attractive than the bond market. Perhaps it's time to look at an immediate annuity where you can get guaranteed income for life.
With interest rates higher, you can lock in a higher payment for the rest of your life. And we looked at immediate annuities in episode 326 and 279. So that's the second thing we can do. We can make sure we have dry powder to take advantage of opportunities as they come about.
The third thing we do to survive a bear market is to manage our emotions. We don't want to get too fearful nor too greedy. And people react differently to bear markets. Some people panic. They can't stand the pain of the volatility of the losses. And again, if the losses will impact your lifestyle, you can reduce risk. But if it won't, then we don't need to sell in fear.
nor do we want to go all in. We should be flexible, make incremental changes. The idea is to protect against the downside, to have a portfolio that helps us survive the bear market so that we're positioned to capture the upside as we slowly reposition our portfolio. The other thing we can do, and I've spent a lot of time really focused on that this year, is just being mindful and focusing on the present.
Not spending time second-guessing and regretting things in the past, nor worrying about the future. That's involved a lot of long walks, breathing, meditation, just recognizing everything will be okay. That we can't control the future. All we can control is our reaction in the present.
The opportunities that arise, just the opportunities to be there with our family and our friends, to be caring to them. Investments is just a minor part of our life. We can control our emotions by not checking the markets too frequently. Don't get so involved in looking at the news and all the bad things that are happening because that can stoke our negative emotions.
I find it helpful to just periodically look at what is happening. Formally, on a monthly basis through our monthly investment conditions and strategy report, I'll look at the newspapers at the end of the day to see if there's anything major I need to be aware of. But beyond that, I don't want to hear news notifications, what's going on. I have no notifications on on my phone.
I don't spend a lot of time scrolling on social media like Twitter because everybody has an opinion and generally they tend to be more bearish, at least the people I follow. I don't want that stress. So control the inputs. Make sure we understand our exposure, that we can survive, have some dry powder, and incrementally make changes as opportunities arise.
but then manage our emotions by not getting too much input. And perhaps you can be like the Stoics and imagine what's the worst thing that could happen. And what would you do? I wouldn't spend every day doing that, but it certainly is a helpful exercise to recognize that things will be okay. We can survive this bear market.
We've done it before. You have done it before. Bear markets give us the opportunity to enter into asset classes at more attractive entry points. Markets can be on sale, which means our returns will be higher in the future. But to do that, we have to manage our exposure now. We need to control our emotions, and then we can incrementally take advantage as opportunities arise.
But all bear markets end. This is part of investing. Volatility is part of investing. Bear markets are part of investing. So please be a patient investor and we will survive this bear market.
One of the ways that we can take advantage of bear markets is by investing in closed-end funds. Closed-end funds are my favorite investment vehicle because I can purchase assets at 20% discounts. And during bear markets, the discounts for closed-end funds get even wider.
It's why we launched our latest course on how to invest in closed-end funds. Closed-end funds allow you to get high income and get that income at a discount. You can get income yields of 6%, 7%, 8%, 9% or more. Last week, we launched this course, giving listeners 25% off. For only $75, you can learn how to be a confident investor in closed-end funds.
I share everything I know in nine lessons. We go online, we go through examples using the tools I use, digging through the financial statements, showing you how to invest in closed-end funds. So please join us. The price goes back up to $100 at the end of June.
So lock in this 25% discount. You can check out the course at moneyfortherestofus.com slash C-E-F. That's moneyfortherestofus.com slash C-E-F. Everything I've shared with you in this episode has been for general education. I've not considered your specific risk situation. I've not provided investment advice. This is simply general education on money, investing, and the economy. Have a great week.