No one knows what they’ll do in a moment of crisis and hypothetical questions get hypothetical answers.

~Joan Baez

When I wrote Another Bear Market: Is It Time to Buy? earlier this week, I tried to summarize the current bull and bear points of view. I also promised to write about how we’re approaching the current market volatility. As I mentioned, I think everyone can and should have a unique response – including the possibility of having none at all – to the market’s gyrations. Our response, therefore, should not be taken as advice on what anyone else should do. It’s based on our personal situation and if that was different, my strategy would be different too.

Background

For those who aren’t regular readers, I’ll just give a quick bit of background on where we’re at financially since it’s the basis on which we’re making our decisions. For the past 10 years or so, we’ve experienced some marked fluctuations in our income stream. That’s because most of our income has come from self employment and/or commission sales. We’ve also been through a lot of job changes over the past 3 years.

This year, we moved to a new city to take a chance on a new job opportunity. At the time, our previous mortgage was almost paid off, but we had to take out a substantial mortgage on our new home due to the regional differential in housing prices. That didn’t sit well with us since we had put retirement and education savings on the back burner for a while in order to pay down the mortgage. Even though our current mortgage represents less than half the cost of the house, it’s about the same size as our old mortgage was 8 years ago.

Now that the dust has (almost) settled from our move, we’re focusing our attention on the income part of our personal finances. We need to earn more in order to pay down the mortgage, save more for our sons’ education and for our own retirement. It’s no easy balancing act, and I’m sure many of you can attest to that. Although this new business opportunity has the potential to be quite lucrative, it will take some time to get things going. Until that happens, I’m going to be a little nervous and I’m going to play it ultra-safe with our finances.

Mortgage, Savings and Expenses

For the first time, we chose a variable rate mortgage on the new house. It’s currently costing us 2.2%. Until we see the income really start to pick up, we won’t be in any great hurry to pay this down. We’ve also got some increased expenses right now due to the fact that our two 16-year-olds are taking some advanced (and costly) music lessons. For the record, we have no debt other than our mortgage.

Secular Bear Market Thesis

For those who aren’t familiar with the secular bear thesis, it goes something like this: Markets are subject to shorter term (cyclical) movements as well as longer term (secular) cycles. I (and many others) think we’re in a secular bear cycle that began around 2000. It could last anywhere from 1 to 9 years more. We’ll know it’s over when valuation metrics like the P/E 10 ratio trough, likely somewhere in the single digits.

In the meantime, I expect to continue to see the kind of volatility we’ve witnessed over the past 10 years. We’ll have some scary waterfall declines, but we’ll also have some short-killing rallies. These rallies can even last a couple of years, like the cyclical bull from 2009 – 2011. By the end of the secular bear, we may have experienced some pretty wide fluctuations, but not much in terms of an overall move. In Shakespearean terms, secular bears are often “full of sound and fury . . . signifying nothing.”

Our approach to this secular bear has so far been to stay on the sidelines, with about 80% of our investable funds in GICs. They are paying 2.5% – 3.25%. We were able to purchase these before the recent drop in rates. For the record, I think rates can fall a little more, and may stay low for some time, barring a bond market vigilante uprising. For now, the vigilantes seem to be hibernating.

The other 20% of our money is mostly in cash, although I do occasionally use about half of it to execute shorter term trades on ETFs or individual stocks. Currently, we have a very small position in HIX, the single inverse ETF for the TSX. We’ve done well with this recently, but I do not anticipate taking a huge position in anything for a while due to market volatility. It can be just as dangerous to be short as long in this kind of tape.

In the Future

I do intend to gradually wade into the equity markets on major pullbacks – and I think there’s a good possibility of those occurring in the near term and into the next few years. I’ll start by buying ETFs with good yields (something like XTR or XUT) and slowly add sectors and perhaps some select individual stocks. I had hoped to be able to add more aggressively to our savings later this year as our mortgage would have been paid off by then. Alas, that is not to be.

Our story is a good example of why financial planning can be so difficult – and why there’s no such thing as a one-size-fits-all plan. It’s also an example of how our investment plan needs to be set in the context of our personal financial background. Not only do you need to have an idea about what investment returns might be, but you need to have some kind of predictable income, spending and savings patterns. It’s all based on a lot of hypothetical possibilities.

Incidentally, I do have a rough sketch in my mind of what I would like our portfolio to look like in the future. It’s subject to change, but it’s been pretty consistent over the past few years. I’ll share some of those ideas with you soon.

As I always say, the great thing about secular bear markets is that they are followed by secular bull markets as surely as spring follows winter.  I look forward to the arrival of the next spring, and I hope it makes an appearance while I still have some peak savings years left!

Do you subscribe to the secular bear thesis? If not, what’s yours?