Worried About a Stock Market Crash?

One of the biggest fears for people approaching retirement or already in retirement is the loss of a substantial part of their hard-won savings due to a stock market crash. After a lifetime of investing experience, I can say with certainty there is a MUCH better way to participate in the markets than buy-and-hope.

The situation we are facing in 2023 is unlike any the US has seen in almost 50 years. The 1970s were a decade with a toxic combination of high inflation, rising interest rates to fight inflation, a bear market for stocks as a result, and high job losses. It’s no wonder the “Misery Index” was created during this time.

2022-2023 is shaping up to be similar to the 1970s:

• High inflation: CPI increased 6.5% over the 12-month period ending December 2022
  
• Interest rates: In 2022 the Fed raised from .8% to 3.83% (now 4.58%)
  
• Stock market: In 2022 the S&P 500 lost -18% the NASDAQ lost -32%
  
• Job losses: Employment is strong for now, but major companies such as Google and Microsoft have begun layoffs
  

To prepare for the future we ought to look back and appreciate the past. If history is a guide, here are some lessons from the S&P 500:

• The Great Depression 1929-1932
  
  • -83% loss from all-time high | 34 months to hit bottom | 15+ years back to breakeven
    
• The Great Financial Crisis 2007-2009
  
  • -50% loss from all-time high | 16 months to hit bottom | 4+ years back to breakeven
    

In 2008 buy-and-hope investors learned the hard way about typical diversification as it is commonly practiced:  equities, bonds, and real estate prices all plunged together. There was seemingly no refuge, and for most people the diversification they relied upon to protect their accounts completely failed them. The lesson of this period is clear - typical diversification does not work when you need it most. 

Those were very challenging times for investors, and Heaven forbid that again we experience all asset prices crashing at the same time.  But - given the amount of total debt and leverage in the world’s financial and monetary systems - we rule out this possibility at our financial peril.

To avoid the worst of a bear market an investor must consider alternatives to the same old ways of investing in the same old markets. The method that offers effective diversification is known as “systematic asset rotation”, also known as “tactical asset allocation”. This type of investing doesn’t rely on holding a static allotment of asset classes in hopes of reducing risk; instead, we own a rotating set of assets based on researched and empirically proven rules.

Here are the keys to greatly reducing the losses from a stock market crash:

1. Using a simple momentum calculation, rotate into strong asset classes and out of weak ones on a regular schedule. This cuts losing positions and lets winners run.
   
2. Know and respect the signals that differentiate a bull market from a bear market. There are times when taking risks is rewarded, and there are times it is punished - we act accordingly.
   
3. If conditions are bad enough to warrant, temporarily go to a defensive risk-off posture in cash or cash equivalents until appreciating assets are found again. There are times when cash is the very best asset class.
   
4. Upon finding performing asset classes, tilt your portfolio in that direction and repeat the process.
   

The proliferation of exchange-traded products (ETFs and ETNs) allows us to easily, efficiently, and systematically invest in baskets of US and international equities, US and international bonds, real estate, precious metals, and even commodities and currencies. Almost always one or more of these asset classes is working in our favor. For example, even during the depths of the Great Depression gold prices moved substantially higher over many years.

While we cannot predict the future, we can evaluate our investing environment and make adjustments as necessary. Utilizing systematic asset rotation and respecting risk-off signals are key to avoiding the worst of stock market losses. If you would like to learn more about how to invest confidently and have peace of mind, feel free to contact me at jon@hancockadvisors.io or (360) 776-6600.

To your investing success - Jon