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How to Bear Down in a Declining Stock Market

Brian O'Connell

With the stock market, and the U.S, economy, demonstrating stronger performance in late 2016, should investors start weighing some options in the event the markets falters, as some experts suggest?

Sure, that's a contrary debate to have as the Dow Jones industrial average is at record highs.

But in a market where VIX-based volatility futures prices are rising, it's a debate worth having, as any investor who survived the market slide of 2008 can attest when the Dow fell 33 percent.

[See: 10 Tips for Keeping a Cool Head in a Market Meltdown.]

Even as stock prices rise, analysts are quick to heed caution. This from Charles Schwab's market perspective: "Stocks slumped in the days leading up to the election, but despite a surprising result, stocks have soared off their post-election night lows. But there is much uncertainty ahead and we expect continued bouts of volatility."

Some market insiders blame the Federal Reserve, which has been slow, in their view, in raising interest rates that could stabilize the stock market over the long term.

"The Fed has put market sentiment before the economy yet again," said Charles Dumas, chief economist at London-based Lombard Street Research, in a recent research note.

"It is doing U.S. stocks no favors by provoking an unnecessary bubble with its certain subsequent burst."

"The economy is running hot, led by consumers," Dumas adds. "Productivity growth has slumped to 0.5 percent, meaning gross domestic product outpaces potential growth by more than 0.5 percent. With inflation already on target, the Fed is encouraging yet another bubble-bust."

An insurance policy against a down market. No matter who's right and who's wrong about market direction, financial experts say having an action plan to implement when the market hits the skids is just good common sense.

"It is always a good time to have a plan in place for the worst," says Mark Painter, a money manager at Everguide Financial Group, in Berkeley Heights, New Jersey.

"The problem with this market environment is that traditional safe haven assets are the most expensive and could demonstrate to not have the desired protection in the medium term," Painter says. "That includes assets such as gold, bonds, utilities, telecoms and real estate investment trusts."

[See: 9 ETFs to Buy When the Market Tanks.]

Be careful in any mad dash to cash, too, Painter says. "Most advisors will also recommend against a cash allocation with low yields," he adds. "However, having some portion in cash is appropriate at this time and can be used to take advantage of potentially higher yields or a downturn in the market."

Jeremy Torgerson, a financial planner with nVest Advisors in Brownsville, Texas, advises investors to keep cool when markets get turbulent.

"Keep your head about you," he says. "Markets move all the time. No one even remembers the 8 percent drop that started this time last year, as today we are at record highs. This, too, shall pass. A sudden market movement means almost nothing to most long-term investors."

Any action an investor does take in a declining market should be made under the guidance of a financial advisor and should be focused on asset allocation, Torgerson says.

"At a minimum, rebalance," he says. "Failing to rebalance after a long climb in stocks will subject more of your money to a correction than you intended. Rebalancing after a market boom basically scrapes the winnings off the top and downshifts them into more conservative positions."

Also, don't wait for a market landslide to rake in some cash, because by then, even the longest rake won't help.

"Lock in profits," says Sam Ali, a money manager with Manske Wealth Management in Houston. "The average retail investor is typically buying during market euphoria. For example, they see an article headline that states Dow Jones hits all-time high of 19,000 and they respond by making stock purchases. I try to educate my clients that this is an opportunity to lock in gains that we've achieved in 2016, and take advantage of purchases after the pullback. Always be thinking buy low and sell high."

For the ultimate heads-up, hire a financial advisor that places an emphasis on client communication, Ali says. "At our firm, the mantra is 'every client, every month.'" We pride ourselves on monthly client communication so that we're keeping our clients and their other advisors informed. During that monthly communication, we're talking to clients about our expectation that we'll see a market pullback so that they are not caught by surprise."

Above all else, don't blow a gasket if the market free falls for an alarming period of time.

"Don't panic," says Deborah Meyer, chief executive officer at Worthy Nest, near St. Louis. "The U.S. has enjoyed eight years of stock market growth. Fundamentally, what goes up must come down."

If and when a market slide occurs, take that time to revisit your long-term asset allocation and see if your portfolio needs any adjustment, Meyer adds. "If you have fresh cash to invest in the market, use that to 'naturally' rebalance toward a good long-term allocation."

[See: 13 Ways to Take the Emotions Out of Investing.]

With the stock market at all-time highs, it's easy to get complacent and take no measures against a potential downturn. But looking the other way is how portfolios get destroyed in bear markets, so have an action plan in place -- just in case.

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