Surviving bear markets

Stephen Thaxter – Senior Partner

Sovereign Wealth Partners


2022 has turned out to be a nasty year for investors.  Almost every asset class is down and several exchanges around the world are in a “bear market” (which is usually defined as being down 20% or more from a previous high point).   

Bear markets can be mild or extreme, quick, or excruciatingly slow.  But they are a natural part of the investing cycle and should be seen as the price we pay to earn long term returns beyond cash rates and inflation. 

For investors in 2022, the jury is out on the pain still to come.  Core inflation is not under control and Central Banks around the world are warning us they’ll continue to push up interest rates, irrespective of recessions.  So, the unpleasant reality is that our portfolio returns may get worse before they get better. 

Of course, this may not be the case. Every day, market professionals exercise their judgement such that today’s prices are the aggregate of their future expectations.  If most professionals really believed there was a big correction to come, the market would instantly drop today as it factored in that expectation.  So, every day the bulls match the bears at the prevailing prices.  

So what actually moves markets is “new” news. It’s the big new or underestimated downside shocks that cause bear markets. Right now, as the price of money goes up faster than anticipated, we’re looking highly vulnerable to the next big piece of bad news. 

As long-time advisers, we’ve seen a lot of bear markets.  When we look back at our experience during the 2008/9 Global financial crisis, we can at least say that we helped the vast majority of our clients survive it.  Our clients lived to invest another day and went on to rebuild their wealth.   

Investors that did not survive, almost without exception, succumbed to one or more of these four traps: 

  1. The investor was unable to endure the panic selling phase and sold out at the bottom.  
  2. The investor was over-leveraged and was forced to sell at the bottom.  
  3. The investor had too little diversification in their portfolio – they had concentrated holdings in assets that suffered a permanent capital loss. 
  4. The investor did not participate in the inevitable upswing after the panic selling subsided. 

So, in a nutshell, what are our bear market survival tips?   

  1. Accept that bear markets are all different, they are a part of every investor’s journey and that the turning points in the cycle are only seen in hindsight. 
  2. Understand that severe bear markets have a final panic phase with near vertical drops in prices.  So far in 2022 we have only seen panic selling in several niche markets, but when this does happen investors feel an almost uncontrollable urge to sell.  As hard as it may be, this is the time to not panic.  This is the time to stay disciplined, rebalance portfolios and not run to cash.  Even if the correct decision in the short term was to cash up, that decision will only be beneficial for those are able to successfully buy back into the right markets at even lower levels.  This is much easier said than done! 
  3. Stay diversified across asset classes and individual investments– extreme losses will likely be smaller. In a similar vein, don’t try to be a hero – you may be “right”, but the market can be “wrong” for longer than your wallet and your patience can bear. 
  4. Avoid high leverage and ensure you and your investments can handle much higher interest rates and margin calls. 
  5. Maintain a valuation framework that can help recognise overpriced and underpriced assets. Such a framework is of limited use in normal times as markets will always overshoot and undershoot their fair values. In fact, in the good times, overpriced assets often continue to appreciate for years. But when the cycle turns, it’s the overpriced assets that fall hardest.   
  6. Understand that no major bear markets have occurred when markets were already cheap.  This gives us the confidence to rebalance portfolios during the panic phase, increasing our holdings of cheap assets.  At this point the further loss potential is actually less and although we don’t expect to pick the turning point we need to remain positioned for the eventual upturn. 
  7. In the good times, stay prepared.  This means keeping generous cash reserves so no assets need to be sold at fire-sale prices.  It also means revisiting your risk tolerance assessment with your adviser at least every few years.  These are the discussions that drive the risk and reward settings in your portfolio and will remind you of the occasional losses you were prepared to accept when you put your plan together. 
  8. And finally, remember the classic Mike Tyson quote – “Everyone has a plan until they get punched in the mouth”.  A good financial plan does not need to predict the next bear market, but it will embrace the uncertainty of returns, incorporate the lessons of history and help you take the long-term view 

Farrellys, our long-term research partner has delved into the anatomy of bear markets and how to survive them.  This abridged article below is a summary of his findings.  Feel free to ask us for more detail. 

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