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Nov 24

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Are you ready for the Bear Market?

76360.TIF“Don’t confuse brains with a bull market.”

Humphrey B. Neill (1895 – 1977)

Stock author; focused on contrary investment concepts

 

It is time to assess your stock investment risk tolerance.

I believe the stock market is in trouble, even though the vast majority of the stock market commentators do not know (or at least acknowledge) it. Although the stock market is currently hitting new highs and has had a tremendous run during 2013 so far, this increase in stock market prices is not supported by either the underlying fundamentals of our economy or the most of the individual companies that make up the stock market.

Since the beginning of 2013, as measured by the widely-following Dow Jones’ Industrial Average, the stock market is up more than 24%. Our country’s GNP has certainly not increased anywhere near that much in the last ten to eleven months. Similarly, the U.S federal deficit, our current political environment, and pretty much everything else pertaining to Washington DC is not in dramatically better shape. So what is supporting the big stock market increase? Most economists will either tell you “nothing”, or will say something about the current U.S. loose monetary policy. I suggest that buying one’s own debt by printing money (i.e., what the Federal Reserve is currently doing) is also “nothing” in the longer term, and will just make matters worse.

As measured by what most everyone else is saying, I am going to go way out on a limb. Not having a really good reason for the increase in valuations (see the preceding paragraph), I am confident that a stock market correction of 20% will occur in the next six months.

A 20% price decline is the classic definition of a bear market, and will simply get us back to where we were a roughly a year ago. Again as measured by the widely-following Dow Jones’ Industrial Average, a 20% decline would mean a DJIA value of around 12,850, which is roughly the price that existed during the first ten and a half months of 2012.

So, am I personally selling my stocks? Nope, and I am not necessarily suggesting that you should.  Although I cannot tell you precisely when the stock market will be up or down, I can tell you that there is considerable downside risk at the current market prices.  So instead of an unequivical sell recommendation,  I am suggesting that, if you do not have the stomach to hold onto your stocks when their prices drop 20%, then you should reduce your stock holdings now. It will be better to sell your stocks at their current prices, than to do so after the prices have dropped dramatically. Alternatively, if you can tolerate the price fluctuation and do not have an immediate need for these funds, you can just wait the whole price fluctuation out, and your investment portfolio will be fine in the long term.

There are lots of risk questionnaires out there. Practically any investment advisor worth his fee will have one. Here is my online interactive risk questionnaire, which I not-so-modestly think is better than most of the others. But, perhaps the best questionnaire is how you reacted to the 2008 market drop. Assuming you had a decent amount in the stock market then, did you sell significant overall stock positions during the fourteen months comprising 2008 and/or the first two months of 2009 because the stock market tanked? If you did, then you need to seriously ask yourself whether your desire to tolerate risk has changed. I suspect it has not, so you need to face up to the serious risk that is embedded in the stock market currently. Chances are, if you sold in the fourteen months I just indicated, you do not have the risk tolerance to be fully invested in the stock market today.

Although it will get you to the same answer, you should rebalance your portfolio to your long-term asset allocation. Such rebalancing is particularly timely now, simply because the stock portion of your portfolio is probably way higher (as a percentage) than you should have, and the bond portion of the portfolio is either flat or down from the last time you rebalanced. This online interactive tool provides guidance of how much of your retirement funds should be invested in each asset class, based on the risk tolerance worksheet described earlier. Importantly, this asset allocation pertains only to retirement moneys. Funds that you earmarked for a more near-term use (like a down payment on a residence, or money for a child’s college education) should be invested more conservatively, based on the timing of when you will need those moneys. History teaches us that the stock market will be a solid investment if one has a long investment time horizon, but may fare poorly for moneys needed in the next couple of years.

 

About the author

David Nolte

I am a founding principal of Fulcrum Inquiry, an accounting and economic consulting firm that performs damage analysis for commercial litigation, forensic accountings, financial investigations, and business valuations. I am a Certified Public Accountant (CPA) and an Accredited Senior Appraiser (ASA), as well as having other professional credentials. I regularly serve as an expert witness involving damages measurement. My litigation-oriented resume is on Fulcrum's website.

Permanent link to this article: http://betweenthenumbers.net/2013/11/are-you-ready-for-the-bear-market/

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