How to Invest in a Bear Market Rally


These are interesting, and complicated, times for investing.

The U.S. stock market peaked 18 months ago, during which time there have been some questions answered and some new questions raised. While there are a few signs of "green chutes," the best indicator, the stock market, continues to stumble along near a bottom.

Pimco's Mohamed El-Erian recently made a rather loud case for not buying stocks or government bonds on CNBC. There is news about colleges slashing budgets due to poor endowment results and news about pension plans needing to take risks previously unconsidered to meet pension obligations. Those headlines prod individual investors to consider their long-term investment plans.

Coincidentally, I have had two media requests this week (one local and one national) on the topic of what investors should do after their investments have fallen 50%, the month-long rebound notwithstanding. Making large portfolio changes after a big decline and in the middle of a deep economic recession is problematic for many reasons.

There have been financial crises before and, while the details are different, there are similarities. Similarities include a big, fast decline and several hope-raising bear-market rallies. Similarities in sentiment include denial of the problems early on in the crisis, panic as the declines accelerate and the growing belief that this time is different.

Making financial life-altering decisions is simply the wrong thing to do in the middle of a crisis. Emotions are more at play now than two years ago. How many times has more emotion helped make a situation better? More emotion likely means less logic. A financial plan calls for savings and compounded growth of those savings. You already know that we collectively do not save enough for the future. An insufficient savings rate and a lack of compounded growth add up to a longer work life and the danger of running out of money.

As we address these questions, there are truisms we must understand with a clear mind before giving up. To be clear, giving up is the wrong thing to do.

The stock market has an "up" year 72% of the time, which means it has a "down" year the rest of the time. As different as this time might feel, most of this has happened before: 50% decline, bank failures, global contagion, depression, an apparent lack of a solution, 12-year round trip to nowhere for stock prices. All this has happened before, albeit with different details.

For many people, the problem isn't owning stocks, but, more likely, owning too many stocks, which becomes a question of proper asset allocation. Perhaps in the future we will see people change their asset allocation, but it is too late—or perhaps too early—to make asset-allocation changes. Does anyone think the best path to portfolio recovery is to sell stocks after a 50% decline? That's an overwhelmingly bad strategy with little chance of success.

This article isn't meant to be a pep talk. It might be a while before broad market averages start to show signs of health (a 25% rally in three weeks is not healthy), but an uncomfortable ride in the stock market for a while longer doesn't mean the market is permanently broken. This is prime time for people to succumb to emotion and sell low. If you do one thing, avoid that mistake.



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