Investors are understandably frustrated by a miserable year in which stocks are in a bear market and bonds have brought no relief. It’s hard not to be pessimistic given the long list of concerns dominating the market outlook – including inflation, central bank policy and the war in Ukraine. Despite this painful year for investors, it is important to maintain a long-term perspective while taking constructive steps that will help navigate a bear market.
1. Use an appropriate frame of reference when evaluating investments.
Investors frequently compare their holdings to the S&P 500 Index, which is not always the appropriate benchmark for an investment strategy. For example, investments outside of the US, in small company stocks or in value stocks should be benchmarked against a benchmark more relevant to the investment universe or style.
Many investors are also too quick to accept short-term success or punish short-term failures. According to Howard Marks of Oaktree Capital Management (opens in a new tab)“Every portfolio and manager will have good and bad quarters and years that have no lasting impact and say nothing about the ability of the manager.”
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2. Take advantage of opportunities to “reap” losses.
Bear markets create a lot of “losers” in which the current market value is lower than the base cost of having it. A silver lining associated with the loss of investments is the ability to realize capital losses to reduce future tax liability. Tax loss harvesting involves selling a position that is trading at a loss, creating realized losses that can be used to offset taxable capital gains or a limited amount of ordinary income.
Unused tax losses can be carried forward to future tax years. When harvesting losses, it is important to avoid violating the wash sale rule, which prohibits losses for income tax purposes if you sell a security at a loss and buy the same security or a “substantially identical” title within 30 days before or after the sale. .
3. Distinguish between patience and complacency.
Patience is a virtue for investors, as stocks must continue to be viable long-term investments.
Complacency, however, can be a trap for investors. There are changes in the investment environment that are likely to last beyond this year’s bear market and may require course adjustments for long-term investors. For example, inflation may be a more persistent challenge than deflation over the next decade. Therefore, investors should consider adding investments that provide inflation protection and inflation-adjusted income.
The war in Ukraine and the rivalry between the United States and China will also create long-term investment shifts, with winners and losers likely to emerge due to fundamental shifts in the investment environment.
4. Avoid relying solely on the recent past as a guide to the future.
Most investors assume that bonds provide a reliable counterweight to equities because for most of the past two decades, bond prices have tended to rise when stock prices fall.
However, the “recency bias” in assuming that negative correlations between stocks and bonds will persist can be a trap for investors. For much of history, in fact, the correlation was positive, with stock and bond prices rising or falling together.
5. The last tip is perhaps the most important: differentiate between the stock market and the economy.
Stocks tend to bottom several months (at least) before the rest of the victims of a recession. The end of the bear market could occur despite bad news on earnings, GDP and payrolls. The turning point in markets often comes when news becomes “less bad” than investors fear or when worst-case scenarios become less likely.
For example, at the start of the pandemic, markets rebounded strongly after the Fed took decisive action to prevent a liquidity crisis from turning into a solvency crisis and fiscal spending provided support to households in difficulty.
In the current environment, the suppression of worst case scenarios regarding inflation, Fed policy or war could be what shifts investor sentiment from pessimism to optimism.
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