How Investors Can Make the Most of a Bear Market

Written by: Kevin R. Clark, CFP®, CIMA®, EA | Arch City Tax Services, LLC

2022 thus far has been a difficult year for investors. The stock market ended last month in bear territory (defined as a 20% or greater drop in price), capping off the worst 6-month start for the S&P 500 in over 50 years. For many, this bear market has felt like death by a thousand cuts versus the dramatic one-month selloff that occurred two years ago.

Unlike other bear markets of recent memory however, most key diversifiers have failed to slow the bleeding this year. The bond market, often considered a ballast against stock market volatility for diversified investors, is off to its worst start in over four decades, with the Barclays US Aggregate index down over 10% through the end of June. Meanwhile, abnormally high inflation has made cash and money market accounts a poor place to park one’s money, gold has yielded negative returns despite oftentimes being viewed as an inflation hedge, and 70% of value in the cryptocurrency markets has been wiped out along with two of their major lending institutions (Terra and Voyager).

In times such as this, my refrain when speaking with clients is six simple words: let’s control what we can control. The ebbs and flows of the markets are largely out of our control, but how we respond to them is fully within our control. Contrary to what our animal instincts may tell us, drastic action is often counterproductive, and trying to time trades in and out of areas of the market around a recession typically just compounds the losses, turning temporary pain into a long-term problem.

So what can investors do right now to take back control? Here are a few ideas:

Understand the history of market and economic cycles

While this recession may feel different due to the scope of asset classes being battered, it’s important to remember that we have been here before, and prior occurrences of today’s conditions were in several cases much more drastic. This is another reason why having an advisor can be beneficial to provide needed perspective.

To wit: there have been many comparisons made between today and the 1970s and 1980s, a period marked by sky-high gas and meat prices, economic stagnation, and an aggressive Federal Reserve Board intent on hiking interest rates to stamp out runaway inflation. All these conspired to cause a US stock market crash of nearly 50% in the mid-70s and then a double-dip recession in the early ‘80s, from which the US economy did not fully recover until the Clinton administration a decade later.

When examining what contributed to these conditions, however, one finds few comparisons to what is happening in 2022. Richard Nixon’s decision to eliminate the gold standard in 1971, de-pegging the value of the US dollar from gold-backed infrastructure, is widely considered a key reason for the subsequent decade’s issues. The US dollar collapsed in value, further weakening an already-reeling US economy and causing inflation and unemployment, already at elevated levels, to spiral out of control. In comparison, 2022 has seen a strengthening of the dollar relative to other currencies with foreign buyers continuing to pile into it as a world reserve currency, as well as near record-low unemployment figures.

Meanwhile, the 1970s saw gasoline prices increase by over three and half times their pre-recession norm, amid widespread shortages and rationing, a far cry the price increases experienced this year. At its peak, inflation exceeded 14% during the double-dip recession, and the Federal Reserve countered this by increasing short-term interest rates to 20% in 1980. Contrast these figures with projections of peak inflation in 2022 around 9% and the Fed’s current target of 3.5% for short-term interest rates, and the predictions of the US entering another era of ‘70s stagflation seem overblown.

Most notably, despite the bumpy ride during that decade, stock market investors were rewarded for their discipline. Those who invested at the start of the 1973-74 crash (i.e. were down nearly 50% to start) exceeded their initial investment in 1980, amidst the double-dip recession, and saw their accounts nearly triple over the following decade. This illustrates two important facts for investors to remember:

  1. Investment markets begin to drop prior to the onset of a recession and begin their recovery while the recession is still ongoing.
  2. The magnitude and length of bull markets historically dwarf those of bear markets.

Review and recommit to your financial and investing plan

The importance of having a plan and retaining the ear of a professional advisor is to navigate years like this. Every investor should take time to remind themselves (or to be reminded by their professional) of how and why they’re investing as they are. A set plan co-created by the investor and the advisor has usually already been stress tested for adverse market circumstances. It can act as a mooring in the storm and provide assurance to the reeling investor.

Many investors that have diligently stayed the course in recent years may have entered this year ahead of schedule on their financial plans, in a position for their portfolios to absorb these temporary losses. In such cases, there is often virtue in a simple account rebalance or rejecting the urge to do something and leaving the portfolio alone.

For those who do need to take action to address a shortfall in their plan, as well as those willing to assume more risk to take advantage of the eventual market recovery, a combination of any of the following could get things back on track:

  1. Increasing periodic contributions to investment accounts
  2. Contributing a lump deposit of excess cash to buy while the stock market is down t
  3. Temporarily increasing risk tolerance to invest a greater percentage of the account in stock, thereby capturing more of the upcoming market rally

Consider Roth conversions for long-term tax savings

Bear markets are often a great time to consider the Roth conversion tax strategy. This involves taking pretax savings from traditional IRAs, pensions, and other retirement plan balances, and converting them to post-tax Roth status. In doing a Roth conversion, the account owner opts to recognize income from their pretax money and pay resulting taxes today. In exchange, the converted funds can begin earning tax-free growth towards retirement.

It is important to discuss the strategy with your tax preparer and to review your tax circumstances before pursuing the idea. Investors already in a high tax bracket, for example, may find the strategy less appealing than middle-income earners or those who have seen their pay cut by a work stoppage or reduction in hours. Age, income, years to retirement, amount of pretax savings (in both dollar terms and percentage-of-all savings terms), where the funds are saved, and sources of funds to pay the resulting tax, are all factors in the advisability of a conversion.

For those that do find it compelling, a conversion now provides the opportunity to reposition a larger percentage of their savings into a more advantageous tax treatment before the investments recover and regain their pre-crash values. Paying the tax now can provide more bang for your buck than doing so when the stock market is trading at or near its highs in a bull market.

Consider for example an investor owning 100 shares of Apple Inc stock (AAPL) in a pretax IRA. At AAPL’s peak this year, the investor would have needed to recognize nearly $18,000 of added income to convert the shares to Roth status. Conversely, had she waited for the stock to bottom out last month before converting, the same 100 shares could have been converted while assuming just over $13,000 in new income…saving her several thousand dollars in taxes while getting the shares positioned to grow tax-free thereafter.

Related: Are Recession Risks Already Priced In?