Don't Get Fooled by "Long Always" Mentality

10/04/2019 9:40 am EST


Landon Whaley

Editor, Gravitational Edge

Landon Whaley concludes his critique of the UBS Bear Market Guidebook, which basically calls on investors to remain invested in stocks at all times.

Today is the final installment in our three-week series exposing all that is wrong with the Old Institution using the UBS Bear Market Guidebook as a case study. Once again, I feel like the teaching moment offered by part three of the UBS guidebook is worth exploring.

Let’s dig into part three of the guidebook sure to elevate the “I’m now eating cat food in retirement” risk for investors around the world.

Part 3 = Fewmets

In this section, UBS lays out four things all investors should do during a bear market: “Don’t panic, portfolio management, play for time and tactical opportunities.”

Don’t Panic

Don’t panic is always good advice, but here they confuse panic with being proacting in the facing of new market data. UBS’ first piece of advice for safely navigating a bear market is to “resist the urge to change the risk profile of your portfolio or make sizeable shifts out of stocks or into cash.” 

Since the advent of fee-based accounts, the Old Institution doesn’t get paid when you sit in cash. In fact, if you raise too much cash in your account, your advisor gets tapped on the shoulder by compliance asking why. The OI needs you invested in stocks, ETFs, mutual funds, and the like because that’s how they get paid.

They want you to stomach the bear market drawdown because to “make sizeable shifts out of stocks or into cash” reduces wealth management revenue at a time when their other income streams are drying up. On the investment banking side of the house, fees are down because no one IPO’s or brings a bond offering in the middle of a bear market. In the prime brokerage silo, revenues are faltering because during a bear market hedge funds don’t lever up (lower borrowing fees), and they trade less (lower commission revenue). 

UBS and other members of the OI will keep you invested even though after a 20% peak-to-trough move you need a 25% gain to get whole again. If your UBS banker convinces you to stay in the equity boat and your portfolio gets gutted to the tune of -34% to -51% (which is typical in bear markets), your portfolio needs to rally between 52% and 105%, just to get back to where you started! But I’m sure there’s a reason, beyond fees, for the OI to keep you fully invested during a market downturn, right?

Portfolio Management

“Investors should use sell-offs as opportunities to harvest capital losses…and rebalancing the portfolio can also enhance upside…These fall into the category of ‘high-probability’ alpha generation, because they’ll probably [emphasis mine] help improve after-tax returns regardless of how quickly markets recover.”


UBS’ first tactic during a bear market is to stay fully invested and then once your portfolio gets the woodshed treatment, the next step in their bear market strategy is to have you lock in the losses because they think its “high probability alpha generation” which will “probably help improve after-tax returns regardless of how quickly markets recover.”

We continue our breakdown of Part 3 on page 11… Now without further ado, enjoy The Weekender!

Folks, allowing your portfolio to get whack-a-moled so that you can generate tax losses is as asinine as me folding up shop to pursue a career as a gymnast. Beyond that, their throw away statement “regardless of how quickly markets recover” shows that UBS doesn’t know the first thing about successfully navigating a bear market.

As we discussed two weeks ago, a vital, and often overlooked, aspect of any drawdown is the recovery period following the decline. The average bear market drawdown in the 60/40 stock/bond portfolio erases an average of 47 months’ worth of gains and then takes anywhere from 30 to 50 months to regain the previous high-water mark. I don’t care who you are, or how much money you have, spending 77 to 97 months in a drawdown and then the subsequent recovery is not good.

Bear markets can be forecasted (and avoided) as evidenced by our call last year. On Sept. 17, 2018, we made the call for a Winter Fundamental Gravity environment and a massive decline in U.S. equities during Q4 2018. Just four days later the S&P 500 peaked at a brand new all-time high and proceeded to drop 19.3% over the ensuing three months.

Being over-allocated to equities (as UBS recommends) during the only Fundamental Gravity environment (Winter) in which a bear market occurs, is the most ridiculous thing I’ve heard of since the remake of “Point Break.”

Play for Time

The third tactic UBS recommends to successfully traverse a bear market is for investors to “look for ways to increase their savings rate or cut back on spending.”

First, UBS says to stay fully invested despite the high likelihood of losing 20% or more of your money. Second, once you’ve stomached the crash in your portfolio, sell your holdings so you can generate alpha by locking in the losses. Third, now that you have one-fifth less money than you did just a few months ago, you should increase savings or start eating cat food to “cut back on spending.” Huh?

Apparently, a bear market is also an excellent time to “consider tapping borrowing facilities as a bridge to avoid locking in losses…”

Wait; what?! Didn’t you knuckleheads just tell us that “locking in losses” was a “high-probability alpha [generating]” strategy?! Now you’re saying I should lever up my balance sheet at the worst possible time (economically speaking) so that I can avoid locking in losses!

I, quite literally, couldn’t make this s*&t up if I tried.

Tactical Opportunities

The final UBS recommendation is to “’lean in “to risk assets when market prices are out of step with fundamentals.” Further, “…it may be appropriate to increase portfolio risk temporarily to take advantage of higher return potential.”

I have just one question: How do you know when market prices are out of step with fundamentals and that it’s the appropriate time to “lean in?”

Based on these stats, you might “lean in” when equities are down 34%, which is the average drawdown experienced during a bear market. The problem with “leaning in” at that price “to take advantage of higher return potential” is that the market could decline another 17% from there. Not only has your original equity allocation been cut in half, but the additional capital you deployed to “lean in” has now experienced its own drawdown of 17%.

The Bottom Line

The headline risk bottom line of our three-week deep-dive is that the Old Institution is not in the business of doing what’s in your best interest. The OI is in the business of keeping you fully invested no matter the environment and making sure your assets stay parked in vehicles that maximize fee revenue by telling you “bear markets are painful but temporary.”

It’s time for investors to take back control of their portfolios, cut the costs of managing money, and dramatically lower the risk metrics and increase the returns of their portfolio. It’s time to empower investors, and we will continue to do our part in moving this revolution forward.

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