Bear Markets Are Not Grocery Stores For Bears
Leaving food unattended and left out while camping is never a good idea. It’s one way to attract unwanted visitors most assuredly. But this quasi-grocery store for Yogi and his type is not the same type of bear market referred to in the title. The Bear Market I have in mind has to do with investing and it is worth knowing what it is, its general characteristics and how to survive them.
What is a Bear Market?
A bear market is a market where prices are receding or declining in value for a prolonged period. Generally, once the overall decline reaches 20% its determined that the market has entered bear territory. Of course, there is nothing meaningful about the 20% threshold. It’s entirely arbitrary but meaningful because it’s an objective threshold. You could just as easily make the case that you’re in a bear market if prices have declined 17% and the general attitude towards the economic and markets is negative.
What is the significance of the bear in “bear market”?
The origin of the term “bear” is not apparent. It likely had to do with the 1700’s era speculative practice of selling bearskins are a certain price prior to capturing, killing, and skinning an actual bear – and the fall out of price movement in the interim. Another explanation has to do with how bears attack, swiping down with their gigantic paw and sharp claws. The effect of being struck in that manner is disorienting at best and deadly at worst. Bear markets can have a similar effect on investor sentiment.
What causes a bear market?
There is not one specific cause of a bear market. Common culprits include poor fiscal policy from the Federal government, geopolitical strife including war, an unexpected change in consumer behavior/spending, pandemics as we’ve recently observed as well as aggressive and sudden changes in monetary policy, i.e., interest rates and money supply.
How long does a bear market last?
Bear markets can be brief (cyclical) yet they can also last a few years (secular) depending on the economic conditions. A cyclical bear market will usually last only for a few months and they are characterized by a change in investor sentiment. A secular bear market is tricky. In these markets, prices decline for a sustained period however there are moments within that overall period of decline where prices go up in a meaningful way – yet overall, they are trending lower. The chart below provides a nice visual on how bear markets are relatively short compared to the recovery that follows. Specifically, the average Bull Market lasted nearly 9 years with an average cumulative return of 468% whereas the average bear market lasted 18 months with an average cumulative decline of -41%.[1]
How to handle a bear market? What to do?
You can make money in a bear market, but it involves a fair amount of risk. You can short the market by selling shares at the current price with the expectation that you will buy them back at a lower price. The risk comes into play in a situation where the market suddenly moves higher, the bear market ends, and you did not close out your short position by buying the security at the lower price. Your potential loss is unlimited and can completely wipe a person out.
Instead, I recommend the following three steps to survive a bear market:
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- Cash for distributions: Always keep available the necessary amount of cash you will need for distributions for at least 9 months. By having cash available for distributions, you can mitigate the prospect of having to sell shares to generate the cash you need for distributions amid a heavy market decline. If you can avoid selling shares during a decline, your prospects for participating in the recovery remain intact.
- Use bear markets as an opportunity to upgrade your holdings. There is a maxim that says, “the stock market is the only market that, when things go on sale, no one wants to buy.” To put it another way, when prices go down, that is a great opportunity to buy companies that were previously too expensive but are now reasonably priced.
- Maintain your conviction and do not let your emotions overcome you. This is not intended to be dismissive of your feelings. For most people their investments represent some combination freedom, autonomy, decades of hard work, sacrifice, legacy, and delayed gratification. Naturally, emotions are tied into the equation here however emotions should be kept in their place when it comes to making decisions about your money.It is only when you succumb to emotions and sell your shares that you actually suffer a loss. Until that point, you experienced a temporary decline. The market has never not recovered from declines. Declines are temporary and so far, the upward trajectory over time has been permanent. When you sell your shares, you are giving your interest to a buyer who is willing to be a little more patient and wait for the bear market to end and that upward trajectory to continue.
Some of the best days in terms of market performance have occurred when markets were during a temporary decline. Missing out on those best days can be costly. The chart below is a great hypothetical. It demonstrates the performance of $10,000 invested in the S&P 500 index from January 1, 1980, through March 31, 2021.[2]
If you were an investor during the COVID-19 Pandemic (2020), Global Financial Crisis (2007-2009), Dot-Com Bubble and 9/11 (2000-2001) , you have survived bear markets. They are not fun experiences, but they are an ordinary part of the market cycle. Most importantly, they are temporary and the market performance that followed previous bear markets should give you every incentive to stay invested during the current cycle.
[1] Source: First Trust Advisors L.P., Morningstar. Returns from 1926 – 3/31/17.
[2] The hypothetical example assumes an investment in an S&P 500 proxy while reinvesting dividends. It does not reflect the effect of taxes, which would reduce these returns. There is volatility in the market, and a sale at any point in time could result in a gain or loss. Your own investing experience will differ, including the possibility of loss.