by David Moon
After writing last week that the U.S. is practically assured of having both a recession and a bear market some time in the next four years, a number of readers asked about moving their money to cash, and then putting their cash back into stocks following the decline. First things first: your asset allocation between stocks, bonds and cash should be based on your personal situation, not predictions about the economy or the stock market. If your personal situation (either algebraic or emotional) cannot withstand a 20 percent drop in the stock portion of your assets, you need to reassess your asset allocation.
Interest rates are too low and stock indices are due a correction, but there is no way to know when rates might increase (has this already begun?) or when the prices of some overpriced stocks might decline.
It is still tempting to time the market, especially when stocks are obviously not inexpensive. Even if we knew the exact beginning date of the next recession, however, it would be of little help in timing the stock market. Recessions and bear markets are different things—and neither is predictive of the other. There have been 12 recessions since 1945; the S&P 500 increased during six of them. The median stock market return during those 12 recessions was a positive 0.15 percent.
Knowing there is likely to be a bear market sometime in the next four years provides little benefit in terms of opportunities for earning extraordinary profits or avoid losses. There are still remain too many important factors that are not only unknown, they are unknowable.
We can’t know how long it will be until the next bear market begins or how much the market will increase before then.
The next bear market low might be higher than current levels. In 1996 an investor who accurately predicted that a bear market would occur within the next four years would have sold stocks at levels below the trough prices of the next bear market—and that was the worst bear market since the Great Depression.
Unfortunately, there is no “all clear” signal when a bear market ends. Bear markets often give the impression of being over, only to reverse course and make new cyclical lows, making the timing of the decision to re-enter the market extremely difficult.
Constantly guessing at the next market decline causes investors to regularly get it wrong even if they occasionally get it right. That is, investors have historically predicted five out of every two bear markets.
The most appropriate determinants of your asset allocation are variables specifically related to you, not the length of time since the last bear market or whether the likelihood of an impending recession is increasing/decreasing.
David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN)