Staying the Course – Global Equity Markets, Hurricanes and Your Financial Future
In 2011, my family and I departed on a three-year sailing adventure beginning in the Caribbean, taking us through the Panama Canal, and across the South Pacific. In the years since, I have shared stories with family, friends, and clients about the once in a lifetime experience that I was able to enjoy with my family, but also some of the challenges such as provisioning fresh food and home schooling our boys on the boat. However, even many of those close to us have not heard about the time we were caught in a major storm between Tonga and New Zealand. Our sails were torn, waves were breaking over the boat and for three days, we were unsure what our fate would be. When the storm broke, we were only halfway to our destination, low on fuel, our chart plotter and radar not working, and the professional weather routers we had hired told us another major storm was approaching from Australia. Yet in the end, we made it to New Zealand, literally burning our last drop of fuel as we pulled into the customs dock.
We had planned for the crossing correctly. We hired professional weather routers to chart our course. We waited for weeks for the best possible conditions. We went with a very conservative plan to minimize our risk. Despite all of this, no one could have predicted that a volcano deep underwater would erupt, heating the temperature of the surrounding sea, causing hurricane type conditions. While we didn’t expect to get caught in a storm, we had a plan. We rode through the storm, did not panic, and survived to sail onward to our destination.
In the over 25 years that I have been advising clients on their investment portfolios, we have experienced our share investment storms. Of the three major bear markets since the Great Depression, I helped clients weather two of them. In both cases, we didn’t see the storm coming, but we had a plan.
We didn’t see this current bear market coming either. At this stage, we really do not know where we are in the course of the storm. It is frightening and we do not know how it will turn out. While this bear market is different from all the others, it is worth taking a look at past bear markets; the amount of the market loss and the years to recover.
The first real big bear market after the Great Depression was the 1973-1974 market crash. The US market lost 45.9% and took 7.5 years to recover.
When I started my company in 1996, the 70s bear market had a great influence on my investment strategy. I knew that I could not predict, nor could anyone else, when a bear market world occur. So I needed to have a plan for our portfolios to survive a bear market. That plan was put to the test right away, as not long after starting the business, the “dot com” bear market hit in 2000. In the 2000-2002 bear market, the market lost 49.7% and took 7.2 years to recover.
The last bear market, what has been termed the “Great Recession,” saw the market take the largest losses of 56.8%, but recovered in only 5.5 years.
Those were difficult times. But we all got through them. And our portfolios got through them too.
How do you survive a bear market? The first and most important part in devising a plan to survive a bear market is to admit that you cannot predict when it will happen and how it will end. By admitting this in the design stage, you build into the portfolio the ability to survive the bear market, living through it, rather than attempting to predict and avoid it.
I like the tortoise vs. the hare analogy when discussing this approach. Yes, the moral most people take from it is the concept of “slow and steady” wins the race. But there is another lesson – survivability. Tortoises have a shell of armor, the very trait that slows them is also its protection. Where the hare’s defense is speed and quickness, requiring it to avoid danger, the tortoise’s protection is its armor; the tortoise can stumble into danger as it has build-in survivability, the hare can not.
The three major design elements to survive a bear market are global diversification, risk factor diversification, and fixed income. The concept with global diversification is that we are sheltered from a bear market that may be limited to a single country. Risk factor diversification means to spread equity investments across all the companies in a country, further increasing overall diversification rather than overloading on large-cap growth stocks. And lastly, fixed income, the tortoiseshell of the portfolio, provides stability in a bear market that for the young allows them to buy stocks at a discount and for the retired, provides a stable cash flow to allow the stocks to recover and eliminates the need to sell stocks at a discount – built-in survivability.
The first two of these design elements really showed their benefit in the 2000-2003 bear market. Navigoe’s all equity diversified model portfolio never went into bear market territory, defined as a 20% loss. For a 2.8 year period it bounced around breakeven, and went positive and stayed that way after 2.8 years – a whole 4.4 years ahead of the US market. When adding the fixed income aspect, the portfolio was seldom negative, as illustrated by the Navigoe 60/40 model.
(The S&P 500 Index is shown for two reasons: First, it is often looked to as a benchmark for the total US market, which it is not. It represents up to 500 US Large Cap, Growth companies. Also, it is market cap weighted, meaning the largest companies disproportionately affect the performance of the index. Secondly, it is the antithesis of the portfolios we build to survive a bear market. It is not globally diversified. It is not risk factor diversified. It holds no tortoiseshell protection such as bonds.)
The results of the Great Repression were not as kind to the plan. It was a global recession, one that hit most countries and most of the companies in those countries. Even a moderate allocation to fixed income did not stop a major downturn. Yet the fixed income did serve its purpose. It decreased the magnitude of the loss, provided buying opportunities for those still working or provided cash-flow – survivability – to those retired. The Navigoe all-equity model took a few months longer than the S&P 500 Index to recover in the Great Recessions, recovering in 5.4 years, about the same amount of time as the broader US market.
The message is that while we do not know when a bear market will come, or how long it will last, with our built in diversification and survivability, we have a plan to make it through the storm and still arrive at our destination.
Global stock markets are currently in a bear market. We are all in the middle of this storm. The good news is that we came in prepared. Our fixed income allocation will provide the necessary cash flow to our retired clients to ride it through. For those still working and investing, this provides an opportunity to buy at discounted prices. We are the boat in the storm; but we have been here before, and we have a plan.
So what I have learned from surviving two bear markets and one storm at sea? Do not panic. Focus on what you can control. Trust your plan. Execute your plan. You will get through this; WE will get through this together.
Next week I will share with you some of what we can control while in the middle of the storm, and the plans we are executing for our clients.