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Registered investment advisor, CFA, portfolio strategy, macro
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Summary

  • The potential for stocks to enter into a major bear market in the coming years is meaningful.
  • This does not mean that investors should evacuate the market today.
  • Timing is everything when it comes to managing your stock portfolio in the current environment.

I wrote my first article for Seeking Alpha back in the summer of 2008. And since that time I have shared over 450 posts on various topics ranging from the economy to asset allocation to the outlook for financial markets.

One of the primary reasons that I have enjoyed writing articles on Seeking Alpha so much over the years has been the rich interaction with my readers. When one of my articles is published on any given day, what I look forward to more than anything else is the comments that I receive from those that have read my posts. What I quickly came to learn about the Seeking Alpha community when I first began submitting articles many years ago is that the commenters are among the most intellectually astute and insightful participants on the website. And it is through the interaction in these reader comments that a variety of specific themes that may have been introduced in a given article are examined and challenged in greater detail, providing me with the opportunity to not only respond but to also explore and refine my own thoughts and perspectives thanks to the contributions of others. Some readers might agree with me. Others may regularly dissent with my viewpoints, in some cases strongly so. And I genuinely appreciate the time that all of these commenters regardless of their views are willing to spend in sharing their thoughts on my articles. I can even now call some of these commenters personal friends as a result of these conversations over the years. I may not have the opportunity to respond to every comment posted to my article on a given day, but I read each and every one and value them all a great deal.

In my latest article The Worst Bear Market Is Yet To Come, I outlined the reasons why I believe that once the next bear market gets underway, it has the potential to be worse than the two most recent major corrections that preceded it from 2000 to 2002 and from 2007 to 2009. My reasons for this view included the fact stock valuations are just as expensive if not more so in many cases when compared to the peak multiples just prior to the tech bubble bursting in 2000, that major financial institutions have returned to a number of the same misguided lending practices that were taking place prior to the outbreak of the financial crisis in 2007, and that the Federal Reserve no longer has the monetary policy flexibility nor the incentive to rescue the stock market the way it did during these past two episodes. Thus, the scenario can be foreseen where the next bear market may end up being longer in duration and the correction greater in magnitude.

My posting of this article understandably led to a common question being raised among those commenting on my article. If I have such a bearish outlook on the stock market, what exactly am I investing in today? Am I in bonds instead? Am I outright short the market? Am I just sitting on cash and waiting for the stock market to correct? The answer? I am primarily invested long of the stock market more than any other asset class right now.

But isn't this disingenuous? How exactly can I write an article on the notion that we could eventually see an even worse bear market sometime in the future and still be net long of the stock market today? The explanation? Timing is everything.

Just because I believe fundamentally that the stock market will eventually plunge into what could be a major bear market at some point in the future does not mean that I think this process is going to get started tomorrow. As financial market history has shown us time and time again, these types of euphoric bull market cycles have the tendency to go on much longer and rise much higher than many might believe possible. In short, while the stock market might peak tomorrow, it may also continue to rise for several months or even years before it is all said and done.

As a result, it makes sense to maintain a long bias and own stocks for as long as the market insists on drifting skyward. This does not mean at all, however, that any such positions are held with complacency. Not only is each position in my portfolio handpicked for its unique characteristics surrounding how it is likely to respond once a new bear market phase gets underway, but I also recognize that the day will finally come when the stock market will actually peak and begin to move in the other direction in earnest. This is where technical and behavioral analysis plays a particularly important role. For while I wish to be allocated to participate at least to some degree in any further upside this already irrational market insists on offering, I also want to be fully at the ready to both act and capitalize the moment we finally see confirmation that the next bear market is about to unfold (such signals might include repeated breaks by the S&P 500 Index (NYSEARCA:SPY) of its 200-day moving average. And as of today, we are not there yet.

Once again, timing is everything when it comes to this aging five-year old bull market. Risks are running extremely high, and investors that chose to ignore or disregard the potential negative future outcomes for the market do so at their own peril. Even if one believes that a major correction is an extremely unlikely possibility, it still does not hurt to ponder such a scenario and the actions that one might deem necessary to take in navigating it if it were to someday present itself.

But beyond my positioning, one comment in particular in my last article inspired a good deal of personal and reflective thought after reading it. I have included an excerpt of the comment below.

"I just wonder whom you are trying to impress with your articles. . . Your motive, I assume, is to facilitate its happening because of your position in the market, because I cannot imagine you are writing these things out of the goodness of your heart."

This raised a great question in my mind. Why exactly am I compelled to write such an article that to some may seem deliberately gloomy and alarming? It is not that I am trying to impress anyone, for I am not someone who is motivated by such things. And I am not compelled to write the article because of my positioning in the market either, as I am currently net long the stock market and would be hurt if the bear market got underway tomorrow. This is not to say that I won't eventually transition my portfolio to a net short position when the time comes, but I certainly am not allocated as such today.

My reasons for writing an article like my previous post are twofold. First, I believe as someone who is focused primarily on risk as part of my investment process that it is worthwhile to try to make people aware of the potentially meaningful negative outcomes that may not be readily evident when following the daily events in today's market place. Because of the Fed's zero interest rate policy and quantitative easing, many investors have been drawn into capital markets for the first time either by choice or necessity and may not be fully aware of the meaningful downside risks to which they are exposed. And given that the daily dialog surrounding stocks is so heavily tilted toward optimistic outcomes, I feel the more voices that are expressing differing views and more balanced perspectives to even things out the better. In short, I do not want to see the unsuspecting investor get caught flatfooted and be badly hurt because they never saw a market disaster coming.

My second reason for writing such an article is more personally motivated by the principles of ethics and justice. What drew me to the investment industry so many years ago was the artistry of fundamental analysis both at the economic and corporate level. I thoroughly enjoy the practice of taking a company, dissecting the financials, identifying opportunities that represent high quality investments that are trading at a discount to intrinsic value and then considering how this opportunity would likely manifest itself given the broader economic backdrop. But over the last several years, the efficacy of such traditional practices has been increasingly compromised by policy actions that have not only greatly distorted financial markets but have also simply not worked in restoring sustainable growth for the broader economy. Instead, what we have been left with is an environment where those that nearly collapsed the financial system have not only been restored back to health but have also been provided with the resources to once again inflate new asset bubbles and create fresh pockets of systemic risk. And this outcome has come to pass at the expense of those that acted responsibly by favoring savings over debt, focused on disciplined investment over rife speculation, and prioritized prudence over recklessness. Regardless of whether it benefits me personally or not, it is the principles of injustice behind the responsible being forced to repeatedly suffer at the expense of the negligent that warrants ongoing discussion on such topics. For as long as this imbalance is allowed to continue, the timing remains right to focus discussion on the subject.

All bull markets come to an end. And the latest installment already ranks as one of the longest at over five years in an economy that has remained continuously lackluster at best. Regardless of whether you think the next bear market is set to begin tomorrow or three years from now, the timing is always right to consider the appropriate course of action to best protect yourself once this inevitable end of the current bull market finally comes to pass.

Disclaimer: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.

Source: Timing Is Everything

Additional disclosure: I am long stocks via the SPLV and XLU as well as selected individual names. I am also long Treasuries via the TLT, TIP and IEF. I also hold a meaningful allocation to cash at the present time.