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Apr 30, 2020

Lessons In A Bear Market

by Ryan Modesto

Ryan Modesto“Investors in 2008 were lucky to get such a good and obvious sale on stocks”. This was a common refrain, in some similar form or fashion, I am sure many investors heard over the last ten years. Looking at a historical stock chart and thinking that buying at the bottom was so obvious is a hindsight bias that we all make, so it can be forgiven. However, our minds are made in a way where we do a good job at putting painful memories behind us and forgetting what it felt like to be in the middle of a crisis. Given the dangers that our short-term memories create along with the dangers of hindsight bias we are all prone to, I am documenting the many lessons learned in the middle of a bear market that we are in, as I go through it.

For some historical context to readers in the CMS archives in the future, (likely reading this through augmented reality glasses) I am writing this in the middle of the March/April 2020 bear market. By the time you are reading this, there will likely be some catchy name for it but in short a ‘coronavirus’ called COVID-19 caught the world by surprise. Much of the spread was due to the virus spreading quickly and going undetected in a lot of cases but a lack of preparedness among institutions across the world also has added challenges, unfortunately. In turn, governments have had to make the tough decision of requiring non-essential workers to work from home and most citizens that are able, to self-isolate in their homes. We are going on to week four of isolation (but it all has really become a blur!) with not a whole lot of clarity as to when this period will end, or what any steps back to normalcy will look like. As one would expect, this isolation component has led to mass closures of businesses with restaurants and retail facing stores being the hardest hit (read as small to medium sized businesses). An added wrench thrown into the system is that it is also wreaking havoc on global supply chains as different factories across the world shut down and open up again, an impact we probably have not fully appreciated at this point. The silver lining (hopefully) is that it does seem like the appropriate steps and actions are being taken and we are approaching a point where the data (related to the virus) starts to improve. In terms of markets, we have experienced the fastest bear market (defined as a peak to trough decline of 20%) in history and the TSX is down 24% over the year with S&P 500 down 23% as I write this. Volatility hit a historical high and market swings of 5% or more have not been unusual in this market. With that all in mind, here are some bear market lessons.

The Emotions During A Bear Market Can Be Overwhelming

This is so easily overlooked when looking at bear markets in hindsight. In a bear market, more is going on than what is happening just in your portfolio. You need to worry about your family, job, and whatever the specific issue that caused the bear market in the first place is. Being a new(ish) father, COVID has been difficult to navigate emotionally as responsibility weighs on you all the more when you have all of these other responsibilities hanging over your head in addition to crashing market values. Knowing what the right action is from an investment perspective is totally different from actually carrying that action out. It is like staring into a raging fire and forcing yourself to run straight through the fire.

You Need A Watchlist Of Stocks You Want To Own

Maybe were at the end of a selloff and maybe we are not but stocks move fast in a bear market and the great bargains do not necessarily last for long. While you do not want to pile in on the first sign of a decline, you need to be ready and have the confidence to take advantage of opportunities when they arise. If you do not have a watchlist at the ready for times like this, you will already be behind the ball and scrambling to catch up. Perhaps more frustrating is that with almost every stock selling off, you can easily hit analysis paralysis without a watchlist by trying to look at every opportunity that is out there. A watchlist saves time and adds focus and process in a time when these things are needed most.

Understand You Will Not Make Perfect Decisions

In a market crisis type of scenario, everyone is working with incomplete information. Expecting to be able to make the optimal decision like timing a bottom is just unrealistic. An investor needs to accept that in the short term, the pain is very likely to continue in a bear market. You will rebalance imperfectly, you will buy imperfectly and you will sell imperfectly. Each of these actions will make you lose sleep at night or beat yourself up during the day. But have faith, because whether you could have bought a stock at a 10% lower price will matter far, far less looking back in 10 or 20 years. The important thing in hindsight will be that you continued to invest through a bad market and not that you made marginal mistakes in the heat of the crisis.

Bonds Still Have A Place In A Portfolio

Bonds have been a tough asset class to make much of a case for given the paltry yields they offer. However, their value is made clear in a bear market. Bonds offer stability and perhaps more importantly, a source of cash for when a market crisis occurs. This can become forgotten near the end of a ten-year bull run but having some stability and a source of cash in a portfolio amid 20% to 30% declines in equities can be a welcome piece of a portfolio.

Be Patient When Deploying Capital In A Bear Market

This can be a very difficult one. As an investor you have probably been waiting years for markets to ‘go on sale’ like this. Possibly the worst thing you can do is to put all of that extra cash you have to work too early. Not only will portfolio values diminish from that point, but now you are forced to sell holdings within a portfolio in order to invest or average down elsewhere. To be clear, I am not saying one can time markets, in fact it is the opposite. Take your time and slowly but methodically put cash to work amid a bear market. Try to avoid spending all of your capital on a 10% decline to only see markets go down another 50% from there! Averaging in is your friend financially and psychologically in a bad market.

Diversification Works But Not Always How You Expect It To

Canadian investors are likely feeling this more than they have in the past. The trusty stalwart banks which have been a go-to investment for generations did not provide much safety for investors in this crisis. Over just a one-month period, some Canadian bank ETFs fell by 35%! Did I say it happened within a period of 30 days? Even utility ETFs were down 33% over the same period in some cases. Meanwhile technology ETFs were ‘only’ down around 22%. The point being is that diversification works but not always how you think it will.

Have A ‘North Star’ To Keep You Anchored

This will be different for each person but in a time like this, it is important that you have some sort of fundamental or inalienable (realistic) belief about markets to help you keep things in focus. This will also help to guide your decision-making process in the thick of things. For myself, it has been the belief/understanding that as long as one can think out past five years, the odds are heavily stacked in my (and your) favour that things will work out ok in the markets. Having a 10+ year investment time horizon, this allows me to remain invested and adding to investments while worrying less about making the ‘perfect trades’ that we know do not exist. Add in the return potential after a bear market and the long-term odds of success are only more in your favour. As a corollary to this, I am confident that looking back in ten years, I would have far more regrets if I was not investing into the declines than the short-term pain of not timing the bottom perfectly.

Panic Early Or Don’t Panic At All

When the news on COVID really started to spread and the impacts were materializing, you had one, maybe two weeks to act (with the benefit of hindsight) before things got bad quickly in the markets. This means, you had one to two weeks to decide around material changes in a portfolio. If you didn’t do it, it was probably too late because the lower markets go, the higher the probability it is that they have hit a bottom making it less logical to sell after the initial big selloff. So, if markets are down 20%, odds are higher that you are at the tail end of a selloff than the beginning. You could sell at this point but statistically it is just the wrong choice. If you are going to react to a recession risk, make sure you do it quickly. The very large assumption here is that an investor is actually able to time these types of events with any accuracy or reliability. Data typically shows that this is not the case. If you do choose to go this route (panic early) and are wrong, just make sure you correct the error quickly as well. Don’t spend your next ten years hoping for another 2008 (or 2020) because you went to cash and never got back into markets. Typically, not panicking and ‘doing nothing’ tends to be the best course of action. However, if you are going to panic, it is far better to do it earlier. If you did not panic early, it is probably too late to do it now.

There you have it, learnings in the midst of a bear market. Carrying out a process like this during these times is helpful, cathartic and helps organize one’s thoughts. It can also be used as a playbook in future bear markets, if they come out of hibernation in the future. I encourage others to try to document their learnings and emotions in times like this. Worst case, it will be interesting to look back at. Best case, it might help you make better financial decisions. And of course, in times that can be stressful for everyone on so many levels, I want to simply wish readers all the best during these tough times as well as health and happiness.

Ryan Modesto, CFA, is CEO at 5i Research Inc. in Kitchener, Ontario. He can be reached at