Plan now when to come back in stock
You need to make a plan now for when you will be fully invested in stocks.
It’s not because the bear market is coming to an end, although of course that is possible. Rather, I base this advice on the almost universal tendency to wait too long before returning.
The need for a plan applies whether you were shrewd (or lucky?) enough to build up cash at the top of the market in January, or whether you maintained your equity exposure throughout this bear market. Either way, you’re probably not currently at your maximum level of equity exposure. The point of this column is that you should make a plan now for when and how you are going to do it.
Why now, you ask me? Can’t you just wait until the time is right?
The clear answer is “No”. The weather never seems good. The only time it will “feel good” to get back into stocks will be the top of the next bull market, because that is when the news will be at its most positive extreme.
Jeremy Grantham, co-founder of Grantham, Mayo, & van Otterloo (GMO), a Boston-based asset management firm, calls our psychological state in bear markets “paralysis.” In a classic essay he wrote in March 2009Grantham wrote that during bear markets “those who [are] overinvestment will be catatonic and just sit and pray. The few who look bright and ooze with cash won’t want to give up their shine easily. So almost everyone [will be] watching and waiting with their inertia beginning to harden like concrete.
Grantham adds that there is an urgent need to develop a return plan, because the longer we wait, the more likely it is that “rigor mortis settles down.
Developing a plan
Perhaps the most important thing to realize when developing a plan to return to your maximum level of equity exposure is that you will not catch the exact bottom of the bear market. The perfect is the enemy of the good.
Instead, come up with a set of rules that specify exactly what will trigger more money to come back into the market and how much of your non-stock holdings you’ll transfer into stocks at each trigger point. Also, make sure your ruleset addresses all possible scenarios. It would be a mistake, for example, to create rules that specify reinvesting your remaining money if and when the market drops even further. In this case, if the market were to rise from current levels, your rules would never bring you back.
To illustrate a possible plan, consider the following set of simple rules: To begin, determine the additional amount you would invest in the stock market to achieve your desired maximum level of equity exposure, and divide that additional amount into five segments. Invest one segment now and invest each of the other four, in turn, whenever the stock market goes up or down 5% from where it was when you invested in the previous segment.
Note that there are a number of different ways these rules would bring your portfolio back to your target level of equity exposure. One would be if the market were to drop 20% in a straight line from current levels. Another would be if the market returns to its January high, also in a straight line. There are many intermediate paths involving various rallies and pullbacks.
Is this the perfect plan? No way. But, as Grantham argued, “the pursuit of optimality is a trap and an illusion; it will only serve to increase your paralysis.
Although the simple set of rules in my example is not perfect, with them you are guaranteed to get an average purchase price below the stock market’s all-time high. So in the long run, these rules will help you gain ground on buying and holding, and reduce your portfolio risk in the process.
My set of sample rules focuses only on price triggers. Instead, you can focus on different levels of valuation metrics such as P/E ratio or dividend yield, or something else entirely. Remember that even a mediocre plan is better than nothing. “Just a clear battle plan – even if it comes straight from your stomach – will be far better in a meltdown than nothing at all,” according to Grantham.
Another urgent reason
There is yet another reason to develop your rules as early as possible: the first few weeks of bull markets are explosive. When the time comes, chances are you won’t react fast enough to capture those gains.
Consider the bull market that started from the March 2020 low. The Dow Jones Industrial Average gained 20.1% in the first week of the bear market low. The first week after the March 2009 bear market low was not so amazing, but still explosive, at 10.2%.
These huge wins are no coincidence either, as you can see from the attached table. The DJIA gained an average of 5.9% in the first week of all bull markets since 1900 in the Ned Davis Research calendar; it gained 12.9% in the first month. These returns are several orders of magnitude higher than the average for all weeks and months on the calendar.
To repeat, though: None of this talk should be taken to mean that the bear market bottom is imminent. I have no idea. In fact, the simple rules I used in my example would yield greater long-term profit if the market were to fall 20% from current levels before a new bull market began.
The fact, however, is that no one knows, and the longer you wait, the harder it will be to put rules in place that will guide you to eventually get back to your target equity exposure.
Mark Hulbert is a regular MarketWatch contributor. His Hulbert Ratings tracks investment newsletters that pay a fixed fee to be audited. He can be reached at email@example.com