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Bear markets can have a positive side | money matters

Bear markets can have a positive side | money matters

By Robert Toomey

One thing we know about financial markets is that they are, by definition, volatile. Ironically, it is this volatility that is a necessary component for the higher returns historically provided by equities. This year the stock market is down in what is called a bear market. A bear market is a market in which the market drops by at least 20%. Although bear markets can be tough to live with, there are a number of reasons why they can be viewed from a positive perspective.

Financial markets are driven by a combination of quantifiable and non-quantifiable elements. Quantifiable items include things like valuations of the economy, interest rates, government and Federal Reserve policy, corporate earnings, and geopolitical factors. Non-quantifiable components include things like investor emotions (known as “investor sentiment”) or geopolitical risk assessments. Quantifiable and non-quantifiable factors can have a significant effect on the valuation or the amount investors will pay for a company’s stock or bond. In a bear market, investors lower (or pay less) stock prices due to concerns about factors such as the factors mentioned above. This year, the main factors of concern for investors have been high inflation, the Federal Reserve’s interest rate policies, the economic slowdown and geopolitical events such as the war in Ukraine.

Bear markets are not necessarily to be feared. Bear markets occur, on average about every four years and on average lasting about ten months. Two key things to note about bear markets are that, like market “corrections” (downward moves of 10-20%), they are part of the normal rhythm of financial markets and can actually benefit markets. . And the good news is that their impact on portfolios can be planned for and mitigated. It is important to note that bear markets can be beneficial because they help to mitigate or eliminate excesses in the markets that can lead to excessive risk or inappropriate capital allocation. They also help prevent investor sentiment from becoming too extreme.

As financial planners, we can plan for bear markets and implement strategies that can mitigate their impact on client portfolios. One way to reduce the impact of a bear market on client portfolios is to diversify across asset classes. This involves holding investments in multiple asset classes such as stocks, bonds, commodities, and real estate. Holding multiple asset classes helps reduce portfolio volatility by offsetting or mitigating the impact of a significant decline in one asset class. Allocation of a client’s portfolio across asset classes can also help mitigate the impact of a bear market by reducing weightings to more volatile asset classes. An appropriate allocation for a client is determined from the client’s financial plan and then implemented into their investments. Normally, a higher allocation to bonds or fixed income securities should lead to lower portfolio volatility, as bond prices tend to be less volatile than stocks during periods of market stress.

Robert Toomey, CFA/CFP, is vice president of research for SR Schill & Associates on Mercer Island.