A few days earlier, the Presidio intersection outside our office had been filled with cars and bicycles competing to cross. Pedestrians and joggers scooted nervously through the crosswalks; a pack of school kids laughed as they ambled along the sidewalk.
Now, except for an occasional nervous car or a ghost-ship municipal bus carrying no passengers, nothing moves. A shelter-in-place order has emptied the streets and closed restaurants, theaters, and other “non-essential” businesses. Sports teams and symphonies have cancelled their seasons; the Olympics have been postponed.
The global markets are trading fast and furious, though. Stocks and other assets have fallen at breathtaking speeds over the past four weeks as the world grapples with a global pandemic and tries to slow the spread of Covid-19 and “flatten the curve” of infections long enough to avoid overwhelming the hospitals.
Stability breeds instability, and investor panic is itself infectious, as the bear market takes a giant downward swipe out of portfolios. Before the crisis, investors asked questions like, “Is Google’s stock currently overpriced?” Now, they run for the exits yelling, “Who cares, get the hell out of here.”
The question for long-term investors is, Has the economy hit an iceberg, or is this a passing storm?
Answer: it depends on what happens next with the health crisis and how soon we can get back to work, both of which remain wildly uncertain.
Welcome to the latest bear market, a land of gut-wrenching fear and worst-case scenarios.
Most bear markets follow a four-stage pattern:
The details of each bear market have varied greatly, though, with the only constant being the feeling of dread that accompanies each one before the eventual recovery. This makes it tough to take advantage of this pattern and profitably time the market while moving through one.
After nearly 50 years in this business, I do not know of anybody who has done market timing successfully and consistently. I don't even know anybody who knows anybody who has done it successfully and consistently.
- John Bogle, founder of The Vanguard Group.
During the 2008 financial crisis, the bottom fell out, as now, and U.S. stocks fell 57% over just seven months before turning back. After the dot-com bust, U.S. stocks slid 45% over the course of nearly two years, slowly arm-wrestling investors to the floor.
Bear markets are so different from each other that it’s usually difficult even to know which stage we’re in. At best, we know that stock prices tend to plunge and later recover before the real economy, surprising investors at both ends. During the middle, asset prices seem to lurch in all directions, giving proof to the adage that whoever invented the roller coaster also invented the stock market.
Compounding all of this is our propensity to make up stories to try and explain the uncertainty all around us. As Nobel laureate Daniel Kahneman has noted, “[W]hen faced with a difficult question, we often answer an easier one instead, usually without noticing the substitution.”1
These stories encourage us to kick ourselves for not acting sooner, since “we had plenty of warning and knew this was going to happen.” And it’s true that we’ve had many warnings. In the eleven years since the last bear market, we’ve had numerous warnings about an impending stock-market crash. But they all fizzled out.
Remember the Greek debt crisis in 2011 that threatened to take down the entire EU? There was also the Italian economic problem and Brexit. In the U.S., there was the 2016 U.S. presidential election that was supposed to tank the market forever, according to Nobel Laureate Paul Krugman, and the tariff war with China that did tank the market in the fourth quarter of 2018.
Yes, I hear you saying, but Covid-19 is different. We had several weeks' notice from China, so surely investors had forewarning to act. True, but other virus scares with SARS, H1N1, Ebola, and MERS were contained. The Wuhan lockdown was unprecedented, but during SARS, Beijing closed schools and entertainment venues, canceled the May Day holiday, and rushed to build hospital-bed capacity. Nearly three months into the current virus scare, the World Health Organization was saying there was still a chance to contain Covid-19, just as they said about SARS years earlier.
Time and again, with the help of hindsight, we tell ourselves we should have seen the crisis coming. This only serves to raise our cortisone levels and induce us to make poor emotional decisions with our investments.
What’s needed, instead, is a bear-market playbook that takes the emotion out of our investment decisions, one that doesn’t depend on forecasting short-term market movements and helps us avoid the extremes of either panic or complacency.
One playbook that has served well during past bear markets is a simple two-pronged approach that any investor can understand:
Keep cash on hand for surprises.
Rebalance the long-term portfolio as markets fluctuate.
Having cash reserves on hand for near-term spending helps avoid the need to sell stocks at fire-sale prices. Rebalancing the portfolio is a contrarian strategy that involves selling assets that have risen in price and buying those that have declined in order to maintain the desired risk profile of the portfolio.
That’s it. There are ways to try to optimize the strategy, but they’re inconsequential compared to the chief difficulty of implementing it: resisting the temptation to throw the playbook out the window when the eventual crisis arrives -- that is, when the strategy is needed most.
The key to resisting temptation is to take the long view. Today, stocks enjoyed a huge upward surge after days of declines, but they could just as easily reverse tomorrow. Until the health crisis resolves and we can go back to work, we may remain in the “panic phase” of this bear market and see continued declines for some time to come. After that, we may have to endure an exasperatingly long period of up-and-down short-term movements.
We just don’t know what will happen next and that will continue to set our teeth and our stocks on edge. The odds are good, though, that, as we shut down the economy to save lives, we’re passing through a terrible storm and not steaming ahead into an iceberg. The question for investors is, who will still be around to enjoy the recovery, and who will stay prepared for the next crisis?
1 “Thinking Fast & Slow,” Daniel Kahneman (2011) p. 12.