Prepare for a Crash, Even If You Don't Think It's Coming

Jeffrey Gundlach was kind enough to let everyone know his view of the equity market Tuesday. For whatever reason, the media scoop up Gundlach equity calls like dogs go for table scraps despite Gundlach's current reign as bond "king." Gundlach believes the S&P 500 has just 2% of upside in his estimation and 20% of downside. Not a great risk reward. I've yet to hear a timeframe for these targets, but I'm guessing it's shorter then yours or mine.

Even if you believe Gundlach is off base, can I offer a suggestion? Prepare for him to be correct. You should do this on a regular basis. Can you handle a 20% correction in the equity market? Have you actually run the numbers? I do the math on a regular basis, and I suggest you do the same. If you lost 20% tomorrow, would it change your lifestyle? If it does, adjust accordingly. Call this your portfolio crash test. Banks do it, why not you?

You can go even in more depth and adjust each stock you own. Example, I own Under Armour. It's trading around $80 as I write this. Could it go back to the low $60s where it was in January? Of course it could. Would I sell it there? Not a chance, at least based on current information. That's more than a 20% pullback, but it's important to remember that many stocks will perform worse than the overall market in time of turmoil.

The purpose of this test is not to solely asses risk tolerance for that drop but also to determine where to get cash from to put to work and how. The global financial crisis caused a 57% drop in assets. I'm in my mid-30's, a drop like that is likely to happen again in my lifetime, but not often. How will I handle it when it does? These are questions you should be able to ask yourself often.

Did you know from peak to trough that the horrendous drop of the global financial crisis lasted just 510 days? Meanwhile the current rally from the bottom is pushing close to 2,500 days. That's almost five times more pleasure than pain. During that time we've had minor pullbacks of 10% and one teasing 20%, which is all quite normal and not signaling a 21st century depression.

As the Schwab Center for Financial Research points out, the average duration of a bull market since 1966 is 1,543 days, while a bear market endures for just 442 days. Before you panic, thinking we are far above average today, the rally that lasted for much of the 90's clocked in at 3,560 days. That rally, totaling gains of 415%, sandwiched a 20% pullback that was just 85 days long and followed a rally of 1,813 days.

The market was in rally mode for nearly 5,400 days in a span of about 5,500. Just think about that. Can you risk missing out on the good days for the chance you may miss a few weeks of bad ones?

I'd love to get a chance to buy the market cheaper. I have cash to put to work, but make no mistake, that's not timing the market. That's planning on being opportunistic whenever a correction might come because I'll never be able to determine when that chance may materialize.

Gundlach is a brilliant man and knows more about investing (especially bonds) than most of us ever will. He can't time the market. People pay him to try, so he must. No one pays us, so we don't need to try.

If Gundlach wasn't making general market calls on a regular basis and merely telling clients, "Things should be okay, I guess." They'll just take their assets down the road to Vanguard and go with a total bond market index and save some fees. He's marketing his services. His timeframe is tomorrow. You and I know our timeframes -- at least we should. It's not tomorrow and varies among all of us.

So go run the numbers on a potential "crash" and see how you come out the other side. An event that cuts the market in half is rare so there's no need to be that dire. You can, just be sure not to be among the folks who were pulling $21.6 billion from mutual funds in March of 2009 and be prepared for a pullback that's always on the horizon.

Your guess is as good as mine as to when the pain comes.

This article is commentary by an independent contributor. At the time of publication, the author held shares of UA.

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