What a Nobel Prize Winner and Yoda Can Teach Us About Navigating Bear Markets

What a Nobel Prize Winner and Yoda Can Teach Us About Navigating Bear Markets

April 12, 2024

With markets making all-time highs, it admittedly feels odd to discuss bear markets.  But, they are inevitable for the long-term steward of wealth. Charlie Munger once described them as the “price of admission” for being a stock market investor.  Our own careers, spanning the past 28 years, have seen four bear markets with declines ranging from 25% to 54%.[i]   They happen.[ii]  And will again. 

As advisors, our primary challenge lies not in predicting these downturns but in ensuring our clients are prepared.  Most financial advisors do this by showing downside scenarios such as the 95th percentile result (i.e. a “worst case” one-in-twenty annual result.)  These are often based on historical returns of the past 100 or so years. 

But, understanding the inevitability of market declines from an analytical standpoint is the first step.  The true challenge for investors is not the numbers—it's the accompanying stories. This is where Professor Robert Shiller's insights become invaluable.

Shiller, a longtime professor at Yale University and recipient of the 2013 Nobel Memorial Prize in Economic Sciences, is best known for his work in the late 1990s around the stock market bubble.  But recently he developed a new lane of study called “narrative economics.”  As Shiller explains:

“The human species, everywhere you go, is engaged in conversation. We are wired for it: the human brain is built around narratives. We call ourselves Homo sapiens, but that may be something of a misnomer—sapiens means wise. The evolutionary biologist Stephen Jay Gould said we should be called Homo narrator. Your mind is really built for narratives, and especially narratives about other humans.”[iii]

When markets plummet, we don't experience them as mere statistics; we grapple with them through narratives.  With a bit of lighter fluid from the financial press, the narratives often revolve around unprecedented challenges and threats.  “This time is different," they say—and they're right. It's new. It's horrifying. And it's seductively convincing.[iv] The power of storytelling reigns supreme, even in the cold, hard world of finance.

Consider the three biggest stock market declines of our careers and some of the narratives that raced around during those days. 

Source: Forbes and Flatrock Wealth Partners. 

So how do we prepare ourselves?

Here is where we turn to Yoda of the Star Wars movies.  During their Jedi training, Yoda attempts to tell Luke Skywalker of the inevitability of fear in his upcoming struggle against the Empire.  Luke replies, “I won’t fail you.  I’m not afraid.”  Yoda leans in with the firelight illuminating his wrinkled and experienced 800-year-old face and slowly replies, “You will be.  You. Will. Be.”

Hard to argue with Yoda.  Preparation begins by acknowledging that the next downturn “will be” unprecedented, “will be” accompanied by powerful narratives and “will be” fear inducing.  The next steps are embedded in the Flatrock investment process.  Establish a Protective Reserve that covers a predefined period of spending.  No matter the narrative, your household will have a preset period of reserves.  Then invest a Growth Assets portfolio that encompasses an “All Seasons” approach of a diversified roster of categories that can weather a wide variety of economic and market environments.

Returning (again) to Charlie Munger, he once quipped:

“If you’re not willing to react with equanimity to a market price decline of 50% two or three times a century you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get compared to the people who do have the temperament…”

Such equanimity is only obtained by preparation – both quantitatively and psychologically – not prediction.  By acknowledging the inevitable and bridging the gap between quantifiable data and the stories that grip us, we move one step closer to becoming better stewards of wealth and ensuring better financial outcomes for our families and communities.

 

 


[i]https://www.forbes.com/advisor/investing/bear-market-history/

[ii] During his run around the country, Forrest Gump stepped in dog poop and explained “it happens.”  Point being, you run long enough and occasionally an errant step lands in the wrong place.  Long-term investors similarly run long races. 

[iii]https://www.chicagobooth.edu/review/economics-and-human-instinct-storytelling

[iv] Big declines will be joined at the hip with a unique and unprecedented economic narrative.  If it was a financial crisis we have successfully overcome in the past, markets wouldn’t decline by 50%!