Bear Markets: Inevitable but Manageable
Bear markets are inevitable, painful and, with proper planning, manageable.
This is my eighth bear market in my 52 years as a wealth manager. The prior ones averaged a peak-to-trough drawdown of 41% in stocks and 25% in balanced portfolios (60% in stocks, 40% in bonds), well in excess of the 20% drawdown that defines a bear market. Each experience was unique: The 2020 pandemic bear market lasted just 33 days, compared with the 32-month average; others dragged on for years.
By our current assumptions, as described by Jake Stoiber here, we believe the greatest potential risk to a traditional balanced portfolio is a 25% drawdown. Most bear markets come nowhere near that, but the short dramatic plunge in March 2020 took us right to the edge of our expectations, with a record 33% drop for stocks from peak to trough and an estimated 22% for our balanced composite.
So how do we manage assets through bear markets? We start by revisiting our clients’ risk tolerance levels. For those in or approaching retirement or who rely on their portfolios for spending, we believe a properly diversified account should aim to have at least 20%-25% in defensive assets or cash. That allocation, along with normal portfolio income, should allow families to cover four to six years of spending including capital calls. (It’s also worth noting that while no one can control bear markets, we can all control, at least to some degree, our spending.)
If that sounds like a lot, consider that it should enable investors to ride out market drawdowns, avoiding permanent loss of capital through forced sales at depressed prices. An investor who sold a million dollars’ worth of shares in the S&P 500 index in March 2020 not only had to pay taxes on the embedded gains, but also lost out on the subsequent appreciation. The same position would be worth $1.75 million today.1
Once we determine the appropriate asset allocation, we are generally slow to make strategic changes to the portfolio unless our view of long-term asset class returns or volatility changes. Of course, as John Apruzzese describes here, we are always looking at relative valuations and economic conditions and questioning our own capital market assumptions. And we do react tactically to market conditions by rebalancing portfolios.
For example, as the equity market cumulatively doubled over the three years ending 2021, we worked with clients to trim equity positions to maintain the agreed-upon asset allocation. In the current bear market, we are taking the same approach, this time considering in consultation with clients if – and when – it’s appropriate to rebalance into equities.
We know it is unlikely that we or just about anyone else will make the correct decision to sell an asset class right before it goes down and to purchase it right before it goes up, so we proceed very carefully. Additionally, we must consider the tax consequences of sales for most of our clients.
Please review Jake’s article and let us know if you have any questions. It can make for uncomfortable reading, which is why not many wealth managers show what drawdowns can really do to a portfolio. We do. Most of our partners have already experienced three statistically “once-in-a-lifetime” financial events (in 2000, 2008, and 2020), so we know the value of planning and preparation.
Our goal is for every one of our clients to be well-positioned to ride out this and future bear markets, and to be able to look forward to the better days that will inevitably follow.
Jeff Maurer is the Chairman of Evercore Wealth Management and Evercore Trust Company. He can be reached at maurer@evercore.com.
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