A Bear Market Checklist To Thrive In A Downturn

A Bull Market Checklist To Living Your Best Life is a good resource for living it up when times are good. But how hard is it really to live the good life when you’re making money hand over fist? Not hard at all.

The real challenge is living your best life during a bear market, which tends to happen every 4 – 10 years since the early 1900s. Bear markets are usually a time of worry and remorse. I hated working through the 2000 tech collapse and the 2008-2009 housing crisis.

We haven’t had a bear market since 2009, although we came close in 4Q2018. Therefore, now is as good a time as any to prepare.

First, let’s look at some data and charts to see where we stand in 2H2019.

 

Global Bear Market Checklist

Citibank’s equity research team crunched some numbers for us by comparing 18 financial variables during the previous peaks in March 2000 and October 2007 versus today.

As you can see from the chart, out of 18 variables, in 2019 only two variables are flashing red and four variables are flashing orange. In comparison, 12 signals were flashing red and two signals flashing orange in October 2007.

It should concern us that the current trailing and forward P/E’s are greater than those in 2007. It should also concern us that the yield curve has been flat-to-inverted for a big part of the year. Meanwhile, global return on equity is declining while net debt is increasing.

Good thing the Fed has telegraphed its inclination to be accommodative going forward. Let’s just hope they don’t have to cut too much because that would signal tremendous economic weakness.

Reliving the 2008 – 2009 period is what we should be most afraid of. If we lose 50% in our investments, we will need a 100% return to get back to even. Worse, we will also lose years of financial progress.

It took roughly five years after the beginning of the Global Financial Crisis to get back to even. Ask yourself how much you’d be willing to sacrifice to live five years longer or be able to spend five years raising your child before never seeing him or her again. For many, that time is priceless.

Whether Citibank is right about no bear market on the horizon, it’s hard to say. But it does feel good knowing that a bunch of economists and strategists who look at the markets all day objectively don’t see a collapse in the near future.

Historical Bull & Bear Market Cycles

This second chart gives a great historical perspective on previous bull and bear market cycles. What’s particularly interesting about the below chart are the regression trend lines.

The middle red regression line shows the monthly average returns. It is currently saying that we are ~112% above the average. If history is any guide, we will either revert back to trend or severely undershoot trend.

The two dotted lines above and below have the same slope as the red regression line. The top line is based on the peak of the tech bubble and the low line is based on the 1932 trough. The dotted lines simply give us an idea of how high and low we can potentially go based on history.

Historical Bull & Bear Market Cycles

The last time we were over 100% above the regression line was in 2000. But during the 2000 tech bubble, tech companies had no cash and no profits. Today, the largest tech companies are all highly profitable with massive balance sheets.

Thriving In A Downturn With A Pre-Mortem Checklist

Now that we have a good idea of where we are in the economic cycle, it’s always good to prepare for something before it happens. This is called “pre-mortem” versus “post-mortem.” You want to have a pre-mortem checklist for things such as:

  • What to do if you get into a car accident
  • What to do if your baby or toddler is choking
  • What to do if an intruder is breaking into your house
  • What to do if you’re having a heart attack
  • What to do if your spouse passes away

When disaster strikes, we often CANNOT think clearly. As a result, we tend to make suboptimal choices. With a pre-mortem checklist, we don’t have to think. Instead, we can follow instructions that were created when we were thinking clearly.

Thankfully, a downturn moves at a glacial pace in comparison to these above disasters. Therefore, we have plenty of time to take action. Unfortunately, because a downturn can take months to transpire, there’s often less of a sense of urgency.

Hopefully, this post will spur you into action. Here are some easy things to do now to prepare for the inevitable downturn.

1) Make sure you have enough cash to last through a downturn. Since 1980, the three bear markets have lasted between three months and 2.1 years. Therefore, it’s best you have enough cash to cover three to 36 months worth of living expenses. Personally, I’d shoot for at least 12 months worth of expenses in cash given we’re close to a record high above trend. With cash yielding ~2.3% or greater nowadays, cash no longer feels like a drag.

2) Make sure your portfolio is diversified enough to match your risk tolerance. If you have a regular stock and bond portfolio, you should understand what the historical returns are for various compositions and be OK with the potential upside and downside. Due to a 10+-year bull market, I believe most investors overestimate their true risk tolerance either because they’ve never lost more than 20% in one year or they’ve simply forgotten what it’s like.

3) Write out your investment objectives. With each investment objective comes an investment time horizon. Once you clearly understand your time horizon, you can better match your risk tolerance. For example, if you’re investing for your child’s college education 16 years away, you can afford to be more aggressive with your investments. However, if you’re planning on purchasing a home within the next 12-24 months, then you should likely be more conservative.

Part of writing out your investment objectives include writing out a regular financial progress report to discuss with your loved ones. If you’re single, you’ll find the process of writing to be incredibly enlightening.

4) Run a Financial SEER Analysis. After you’ve studied historical returns and written out your investment objectives, it’s time to quantify your risk tolerance through Financial SEER. Our minds often belie our actions. Financial SEER forces you to come to terms with how many more months you must work to make up for your potential investment losses and adjust accordingly.

5) Make sure your work relationships are strong. The people who get fired first during a downturn are those who are most disliked, followed by those who are the worst performers. If you do not have a wide and strong safety net of colleagues who will go to bat for you, then you best develop these relationships now well before you need them.

Take colleagues out for lunch or coffee. Go to happy hour even though all you want to do is go straight home and rest. I have personally survived ~20 rounds of layoffs during my time in finance and I can assure you that high performers are not safe if they are reclusive and/or prickly.

6) Have at least one alternative source of steady income. The more income streams beyond your day job, the better. But you must have at least one alternative income stream that can help cover your basic living expenses as you try and survive tough times. Ideally, this alternative income stream can grow if you spend more effort. For example, you might be a freelance writer making $500 a month with 10 hours of work. You could easily put in 40 hours of work a month to earn $2,000 if necessary.

Side hustle opportunities, dividends, and returns all tend to decline during a bear market. Therefore, look for countercyclical income and investment opportunities as well.

7) Collect on outstanding debt now. Defaults skyrocket during a recession. If you have any outstanding loans, you should consider collecting when times are good. If you like to invest in debt instruments, perhaps it’s best to only invest in loans with short maturities, rather than ones that may expire in the 13th year of a bull market. The same goes for private equity or real estate investments.

8) Consider raising rents. Only professional landlords with zero emotions can capture the maximum amount of rent when times are good. For most mom and pop landlords, we feel badly raising the rents to keep up with inflation or stay even with the market, so we don’t. However, individual landlords should absolutely treat their rental properties like a business. If you do not raise the rents to keep up with the market when times are good, you’ll have a tougher time raising the rent to market when times are bad.

For example, I have one rental that hasn’t had its rent increased in three years because I feel bad doing so. It could probably earn at least $300 more a month, or $3,600 a year, but I’m unwilling to send them an e-mail notification. Yet, I’m willing to fight tooth and nail to refinance my primary mortgage down in order to save $250 a month in interest to improve my family’s financial situation. Go figure.

9) Reconsider your safe withdrawal rate. If you are already retired, see if you can reduce your withdrawal rate and still live a comfortable lifestyle. For example, if you’ve been regularly drawing down 4% of your portfolio, see if you can live off a 3% withdrawal rate and save the 1%.

Even if you match your withdrawal rate to the risk-free rate of return, it still might be too high because your investments will likely lose money during a bear market. Therefore, the more of a buffer you can build in retirement, the more you can withstand a bear market.

10) Don’t retire until things get bad. Retiring in a bull market is more dangerous than retiring in a bear market. The main reason is that we tend to extrapolate our returns and withdraw more aggressively when times are good. If you retire in a bear market, the chances of things getting much worse are low. But if you’re able to retire in a bear market because your investments and alternative income streams cover your desired living expenses, any incremental improvement in the markets and in the economy is just gravy.

You get to make max money during a bull market. Take advantage of the good times for as long as possible until things turn bad. Only after 1-2 years of living through a bear market should you consider giving up your main source of income.

A Bear Market Checklist To Surviving A Downturn

Bear Markets Don’t Last Forever

Although going through a bear market is painful, the stock market has made money 95 percent of the time over rolling 10-year periods since 1926. Over a rolling 20-year period, it’s made money 100 percent of the time.

Unfortunately, we will all eventually run out of time. Running out of time is why I’ve put together a bull market and bear market checklist. Ideally, I want us to live our best lives possible all of the time.

Having to spend time to recoup losses is a terrible waste of time. As you get older and wealthier, you no longer want to worry about money anymore. All you want to do is spend time on what really matters.

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