What's the Right Bear Market Strategy?

Investors ran to the safe haven of U.S. government bonds along with gold and the yen in January. The yield on the 10-year Treasury note, which declines as its price rises, fell in correlation with moves in the price of oil. Yielding as much as 2.25% at the beginning of January, the 10-year briefly broke below the 2.00% level by mid-month.

However, Santschi said he's not bullish on gold because price action hasn't been good for a long time and gold can be correlated with the downward movement of commodities.

So where are advisors putting their money? According to a State Street Global Advisors survey released at end-2015, 814 respondents, 54% of whom are affiliated with broker-dealers, reported that their favorite asset classes were U.S. and international equities as well as investment-grade fixed income. Advisors said they were overweight in the technology, financial and health care sectors but underweight in utilities, materials and energy.

Brad McMillan, chief investment officer for Commonwealth Financial Network, said U.S. companies haven't been doing too badly, but the energy sector's terrible results have helped take the market down.

"This decline is probably getting close to the end — oil is not going to zero — but it may still continue for several quarters," McMillan wrote in a Jan. 26 comment on the cost to global markets of cheap oil.

Fund Flows

The fund market also has felt the effect of the decline. TrimTabs research shows investors running for the exits. U.S. equity mutual funds and ETFs shed a combined $30.9 billion in the first weeks of January, with outflows at their highest in any month since April. Strangely, Santschi noted, global equity mutual funds posted estimated inflows of $1.2 billion in the same period while global equity ETFs redeemed just $3.3 billion, even though these mutual funds were down 9.1% and the ETFs were down 9.9%.

"I think people are waiting for central bankers to ride to the rescue. Europe has a lot of problems, arguably worse than in the U.S., but U.S. investors have favored European stocks in recent years. They seem reluctant to let go of them," Santschi said.

Heidi Richardson, head of U.S. investment strategy for iShares, apparently shares a view in line with U.S. investors. On Jan. 26, she advised investors preparing their portfolios for volatility to take advantage of buying opportunities in Europe, which remains in a monetary easing cycle that should help regional credit growth and stocks, as well as Japan, where stocks should benefit from sustained monetary policy easing in 2016.

As for robo-advisors, their brief history during a bull run has meant little experience with bearish sentiment. But much like traditional advisors, they are urging their online investors to stay the course with their relatively fixed allocations based on age, risk tolerance and financial goals.

For example, robo-advisor Betterment, in its January 2016 newsletter, reminded investors that market drops are an expected, unavoidable part of investing.

"Remember why you're investing," wrote Dan Egan, Betterment's director of behavioral finance and investing, in "What to Do After a Market Drop." "If you're saving for a long-term goal, such as a retirement, your allocation already factors in a short-term market drop."

Egan went on to say that during the last big market drop, on Aug. 24, 2015, the "vast majority" of Betterment customers followed the robo-advisor's advice to "stay calm and stay the course," and did not check their accounts too frequently. Eighty-three percent didn't log in over the weekend following the drop, and the login rate was about the same as the previous four weekends when the markets hadn't dropped, Egan wrote.

Inevitable Volatility

Indeed, market volatility can be depended upon, according to Brent Burns, president and founding partner of Asset Dedication, San Francisco, whose independent RIA clients outsource their asset allocations to the firm. Asset Dedication balances the risks of volatility and longevity through a goals- and time-based approach using individual bonds to match a retiree's income stream.

Taking an historic view, Burns said that dating back to 1926, the S&P 500 and its predecessor index have averaged an annual return of 10.1%. Over the decades, he noted, the index heads downward about 25% of the time. When Burns sees a market like we're in now, it doesn't change his resolve or how he makes decisions about building a portfolio or allocating assets.

"Markets are volatile and they will continue to be volatile in 2016, at least what we're seeing so far," Burns said. "To get to the 10.1%, you have to take on this volatility. It's certainly sexier for market timers and stock pickers to talk about switching stocks when the market is overvalued or undervalued. Unfortunately, market evidence shows you can't do it consistently. I look at stock investments as at least a 10-year horizon, if not 20 or 30 years. In that case, the bear markets of 2002 and 2008 don't matter. They just become blips in the background."