The 2022 bear market in stocks, bonds, crypto, and housing was a classic textbook case. Although our research suggests that the bear isn't dead, it is definitely aging and we can see a glimmer of light at the end of the tunnel. It has had all of the classic bear market traits - periodically fooling investors throughout the year into thinking it is over and then plunging further downward to new lows. Another classic trait is the decline in stock values, which truly reflects the dysfunction in global economies - mostly based on inflation. As we start a new year, it is a great time to outline what is to come in 2023. Let's dig in!
When Will the Bear Leave Town?
Bear markets are almost always a result of troubled economies and eventually are resolved by both time and price. In terms of time, historically bear markets last between 9-15 months, and we are approaching the 13th month. In terms of price, our research suggests that we are making progress. The price of large global stock indexes had declined by 26% at the lows while technology heavy indexes, such as the Nasdaq, have been down over 35%. As you know, we have been very conservatively postured since late February of 2022, so we have not experienced declines of these levels nor the significant volatility most investors had to endure throughout the year.
How much lower do stock prices need to go to resolve the current bear market? We would suggest that, like the time element, we have made progress but there is probably further downside ahead. Historically during bear markets, indexes decline by a total of 38% - 55% depending on whether they are discounting a mild recession or something worse. In our opinion, the odds of a mild recession are very high as the Federal Reserve's interest rate hikes are making progress on taming inflation. But there is more work to be done. This puts the chances of a further decline in stocks more likely in the first quarter of the new year. However, there will be a point where stock prices have fully discounted all of the bad news and the bear market will be officially over. We are getting closer, but we are just not there yet.
When the Bear is Gone, We Will Welcome the Bull
Once this bear market is finished with its work of bringing financial markets back into equilibrium with global economies, a new bull market and business cycle will be born. Although we plan to remain cautious and conservatively postured until the bear market's time and price are resolved, our team is standing ready to re-invest capital to participate in the next bull market. We are dealing with the known and unknown, so we shouldn't expect to be perfect in this endeavor. However, new bull markets are very powerful in their first 18 months, often pushing indexes up over 30%. The key is to protect capital before the birth of a bull market - which we have been able to do - and stand ready to ride the bull as it leaves the stable. Over the last three decades, we have approached the reinvestment process in phases, often buying four to six businesses at a time to phase back into markets. This process of effectively reinvesting when opportunities present themselves is something we are all looking forward to!
The Bull Market Portfolio
The key to successful bull market investing is to bring your portfolio back to the upper range of your stock allocation in a short period of time, as well as in the right stocks. In terms of making these adjustments in a timely fashion, we have already made a list - and checked it twice - of great companies that we want you to own. Hence, we stand ready. Usually new bull markets are a little different from those that preceded it. For instance, in the last bull market, it was imperative to be overweight the technology sector to achieve better-than-index performance. While we envision that tech stocks will perform well in the new bull market, many other sectors will also likely perform exceedingly well. Technology stocks were the biggest beneficiary of the Fed's now long gone "zero interest rate policy," and with interest rates unlikely to go back to zero, other sectors will have room to flourish on a relative basis. These are just a few of the thoughts we have incorporated into our new bull market portfolio strategy. We look forward to putting this into play on your behalf.
Interest Rates and the Bond Market
If there was any silver lining in 2022's bear market, it was that rising interest rates have created great values and attractive forward returns in the bond market. As you know, our bond traders have been busy "locking in" some great yields for you in your bond portfolio. Most of these bonds are "laddered" with some coming due in short, intermediate, and long-term periods of time. These yields will go a long way to helping your portfolio meet financial planning objectives during the next business cycle. As a reminder, your bonds can be sold at any time; the maturity date is only indicative of when the bond is officially repaid to you.
International Investing Will be Alive and Well
It has been a global bear market and nothing has been spared here at home, or abroad. When we screen stock fundamentals from around the world, we see tremendous value in foreign stocks in specific sectors. In the next bull market, it will add value for all investors to have exposure to U.S. and non-U.S. stocks. At some point, hopefully in 2023, the war in Ukraine will end and the rally in foreign stocks will likely be unparalleled. We will stand ready in our bull market thesis to include foreign as well as U.S. exposure.
Taxes: Protecting Capital Creates Capital Gains
As you know, to protect capital in your taxable accounts, we reduced your stock exposure. This created capital gains for many long-term clients. Keep in mind we have reserved cash for any capital gains taxes until they will need to be paid to the state and federal government. Although few people like to pay taxes, it is better to pay 2-4% of your portfolio's value in taxes as opposed to sustaining a significant and catastrophic loss that could take years to recover from.
The New Bull Market and Active Risk Management
As we remain conservatively postured and ready for the next new exciting bull market and business cycle, we also want to stay on our "toes" for the unpredictable. If positive events occur quickly, such as inflation data plummets, or the war in Ukraine comes to an end, we will be ready to alter our strategy. Also, keep in mind that as we reinvest in our bull market portfolio, we will be applying our Active Risk Management process to avoid any unforeseen return of the Bear.
New Year's Resolution: Financial and Estate Planning
There is tremendous value in our no-cost financial planning services. If you haven't taken advantage of this service, we highly encourage you to do so. We build a financial "road map" for you and your family, which sets the tone for making your assets last your lifetime and for generations. Further, if you do not have an estate plan, this is a great time to put this on your list of New Year's resolutions.
We hope you find this year-end strategy update helpful, and from all of us, we wish you and your family a very Happy New Year.
Your Team at Main Street Research