Rules for surviving and thriving through a secular bear

I entered the money business in the mid-90’s.  Fresh from the basic entry exams in securities, financial planning and broker training school, it is horrifying to me now how little I knew or understood.  Entering the business near the end of the best bull market in human history, I was a liability to myself, my family and the firm clients.  I was taught nothing of value and yet my business card said that I was an “expert.”  For the first time in my life, I felt like a complete screw up and a fraud.  I will never, ever forget the experience so long as I live. 

I remember a few years back that I was pouring these confessions out to my dear mentor and financial market giant Peter Bernstein, sadly since deceased.  “Oh I know,” he replied, “I had a similar experience in the early 70’s. So long as we were in the long bull market in the 50’s and 60’s, we could do passive allocations to equities and think that was doing something useful, then the secular bear market started in 1966, and by the early 70’s it was clear to me that we were wrong, everything we had advised and thought no longer made sense.” Bernstein quit the management business in the early ’70’s and devoted his life to research, writing and educating investors and advisors about the risks and realities of investment theories.

Our best lessons are often hard learned. On the upside, the memory and personal horror of the traditional theory approach became the catalyst and inspiration to everything I have learned, done and taught others since. Facing facts and completely changing our thinking and approach have been the making of our firm, our clients, and our self-respect today. (Yes change is possible and good, although the revamp phase is a lot of work!). On the downside, most of the wealth advisory and management business today still blindly live in the land of worthless nonsense, dispensing ideas and concepts more likely to harm than help anyone paying them for their service.

In this light I was very happy to read this honest and useful article from The Reformed Brokers Josh Brown. Always nice to have others helping to spread the word: Downtown’s Rules for Surviving a Crash.

You want to survive this crash and the next one? Then follow Downtown Josh Brown’s Rules for Surviving a Crash:

1. Acknowledge that it’s a crash. Once we’re past down 10% in the Dow Jones Industrial Average from wherever the peak was (yes, the Dow is a way better crash gauge than the S&P 500), you can stop saying correction and start saying crash. Better to be wrong in hindsight on the nomenclature.

2. Pencils Down! Whatever trendlines or individual stock research you were working on needs to be shelved for the moment. Your drawings and calculations will not work here. If you happen to buy a stock and it rips higher, it will not be because of your research, it will be because the market went up. Correlations always get jiggy in crashes, stocks become commoditized like bushels of wheat that must be liquidated regardless of the underlying businesses.

3. Don’t listen to “stockpickers” or sell-side equity analysts. They are only looking out from within their own little bubble and they cannot comprehend the other little bubbles around them let alone the whole bathtub. Anyone covering specific stocks needs to know when the macro gyrations trump whatever earnings they’ve estimated or the conference calls they’ve listened to. There’ll be a time to “know your stocks” but this ain’t it.

4. Ignore the asset-gatherers and the brokerage firm strategists, their job is to calm markets and soothe investors. Let’s say Morgan Stanley runs $1 trillion in stock market wealth for investors. And then let’s say they felt there was serious trouble ahead. Do you really think they would ever make the sell call? Can Morgan Stanley really say “Sell 20% of your equities”? No. Because that would be $200 billion in supply hitting the stock market at once – they would crash it all by themselves! Too Big To Keep It Real has always been the problem with the wirehouse advice model.

5. Make sacrifices by reducing stock exposure by beta and volatility. This is my iron-clad rule. The moment you recognize the crash, kick the small caps, biotechs, emerging markets etc. You must separate your feelings for a particular asset class, sector or individual stock and recognize that the higher the volatility, the worse they’re gonna act in the short-term. I have a prenuptial agreement with every position I put on and we get divorced cleanly in a crash situation if need be.

5a. Also, margin balances must get cleaned up immediately, take the losses, I don’t care. Because broker-dealers and clearing firms can and will raise equity requirements right at the moment of maximum pain and force you to sell out later – and lower. I could tell you war stories you would not believe, kids.

6. Make two lists. The first list everyone knows about and talks about – the “if they get cheap enough I’ll buy it at that price” shopping list. Fine, but don’t forget the “things I will sell on the next bounce list”. Even the worst markets have short-term bounces in the midst of the chaos, use these bounces to get rid of the things that make you ill on the red days, even if you’re taking a loss. The stocks you bought on a flyer one day or the companies that have been disappointing or where the story has changed – sell ’em on the rips.

7. Watch sentiment more closely than technicals or fundamentals. Pay attention to the squishier things in a crash moreso than you would normally. Are people screaming in pain? Or are they still looking for a bottom? Or have they given up entirely? There is no math to this, a lot of it is “feel”.

8. Abandon any hope or intention of catching the bottom. You won’t and it is unnecessary. No one will carry you out on their shoulders if you manage to do it but you will definitely get carried out on a stretcher if you get it really wrong with your own capital. Keep in mind that time becomes more important than price…not where will it end but when?

9. Suspend disbelief. “Bank of America could NEVER be a $5 stock!” “How could Bear Stearns possibly go out of business, its a hundred-year-old firm!” “No way this stock should trade at 5 times earnings, it’s a Dow component!” “How could the market go down 5% four days in a row?” Guys, anything can happen in a crash, there are machines making the trades and they have no respect for the prestige or standing of a particular company. This is both gut-wrenching to behold and great for the level-headed who eventually got to buy Wells Fargo in the teens or Apple in the $100s once the bottom was in.

10. Stop being a know-it-all and shut up. If you are telling people a price or a support line where the selling will end, you are only kidding yourself. Have a guess based on your discipline and research, but don’t act like you’re talking facts. Fair Value is fine, but call it a guideline. Support is also fine, but call it a historical estimate of where buyers have come in before. The deal with crashes is that extremes are the norm, not the exception. Things tend to overshoot through reversion to the mean trendlines or fair value estimates on their way back to stasis.

Anyway, I’ve been through a lot of these, and I promise you I’ll find myself standing tall on the other side of this one. Following these rules will give you a shot at doing the same.