Good morning,
Today I wanted to discuss bear markets, and some of the mentality problems we may face as investors. Moreover, I want to discuss how we can overcome them, and benefit from bear and bull market cycles.
You will recall that a few weeks back, I discussed the Templeton Curve . Feel free to check that out before moving forward, as I feel it will benefit the discussion today.
Bear markets are daunting for all investors, and perhaps especially newer investors who have not yet faced one before. But they do not have to significantly impact your long term investing goals.
Recall that I have previously stated that a bear market is defined as a decline of more than 20% from the highs. In March the S&P 500 index declined 31%, which was an entry into a bear market.
Image from Investco
Bear markets do not last forever. Whilst it may be hard to remember this during the depths of a severe market decline or a long stretch of market volatility, you should try to acknowledge that a bull market will follow the bear. This is all part of the market cycle that we discussed in the Templeton Curve article.
When bull markets follow on from bear markets, they usually wipe out the declines from the bear market a great deal faster than most investor’s first anticipate. To add to that, bull markets tend to stick around a great deal longer than bear markets.
Take a look at the chart below, provided by Investco’s historical trends research paper.
The chart depicts the S&P 500’s historical performance during bull and bear market cycles. What is clear to see, is that bull markets last a great deal longer than the average bear market, and the returns from bull markets typically always erase the losses from the bear market.
Investco reported in 2020 that the average bull market cycle is 1,742 days.
Whilst the average bear market cycle is just 363 days.
You will see a few notable exceptions in the chart, in the year 2000 for example, but the fact of the matter is, for long term investors, the bear markets are simply blips. Of course it would be more beneficial to avoid the bear market completely, but we will discuss that shortly.
One common mistake a large number of investors make is that during the volatility of an intense market decline, they feel the urge to act. This urge often translates into selling your investments, with the intention of protecting downside or further losses. This is a fairly understandable response. Investors will sell their positions and tell themselves they will buy back into the market when it feels safer.
Succumbing to this ideology will likely dent your long term returns.
In my view, adopting the rationale that you should sell your holdings during a bear market decline, will result in your realizing and locking in losses. This also raises the risk that you will get inferior entry prices once the bear market snaps back into a bull market. The period when a bear market revolves into a bull market tends to be sharp and rigorous.
This could lead you into a circumstance where you sell into the lows, and miss the rebound once the the bull market sprouts from the ashes of the previous bear market. .
Take a look at the above chart illustrating the shortest ever bear market in the S&P 500. Rebounds are not usually so fast. If you look at the year 2000, after the tech bubble popped, you will see that it took a number of years before the S&P rose above the previous high.
The principle is the same however. Bull markets always start with explosive growth.
People often jestingly state that “stocks only go up”.
Stocks are designed to go up.
Long term, equities will continue to ascend due to the nature of human emotion and the impact of ‘profit motive’.
Profit motive, will inspire future entrepreneurs to innovate, which in turn, leads to superior product offering, greater efficiency, and new industries and corporations to populate those industries.
As long as these factors remain in place, we can expect bulls to follow bears.
In the capitalist environment we occupy ( for most of the world ) , it has demonstrated it’s resilience to external shocks.
Just take a look at the chart below, which is a logarithmic depiction of the S&P 500 over the last 60 years. The grey lines are recessions, and the market overcomes each and every one, through innovation.
These recessions have included large scale shocks with regards to macro factors like low or high interest rate environments, hyperinflation, inflation and currency crisis. What’s more, the markets have also survived world wars, trade wars, pandemics, regulations, natural disasters, financial crashes, social conflicts, and an endless list of further examples.
Even during all these events, when we take a zoomed out view, the market continues the uptrend.
Why?
Simply because capitalism will always incentivise the development of new innovations, improved productivity as well as the demand for increased standards of life.
Who among us can predict the future?
It is most certainly impossible.
You have to understand that bear markets are unpleasant, but also that being in a bear market is not an event that will destroy what you have created thus far, nor will it severely impact your goals. This statement is especially true if your time horizon is longer.
Here is the largest take-away from today:
Capturing the FULL extent of the bull market returns is critical
This can only be done, if you are in the market for the entire duration of the bull market.
It is understandable that most investors would seek to avoid a bear market in entirety
This is certainly a task that is somewhat accomplish-able, but proves to be very difficult.
The reason being, that for most everyday investors, a bear market is incredibly hard to identify and time to perfection.
That being said, it is certainly possible to identify the bear early and re-allocate your portfolio into one that is defensive. A defensive allocation may help you suffer less losses, but the same still goes, you must then be able to time the subsequent bull market and re-allocate to the appropriate portfolio weighting. This proves difficult in practice.
Timing the bears is very hard.
Instead, it may be useful to simply avoid some of these detrimental behaviors that we have discussed today and stay invested.
If we aggregate the returns on the S&P 500 over the last 50 or so years, we will see that on average, the market returns 8% per year. This is including all of the bear markets.
For long term investors, this means that avoiding bears is not an essential component to long term wealth creation.
Bull markets will typically erase all bear market losses, given time. As discussed, you need to be involved in the entirety of the bull to capture the entirety of the returns.
For me personally, the bear market in March was a period where i utilized capital heavily. As chance happened, i had been saving a large amount of cash, not in anticipation for a bear market, merely just out of fortunate chance. It is fair to say that i likely invested a larger amount that i have for the previous two years, over the course of 3-5 months this year.
- There may be questions that you have after reading or listening to this newsletter today. It is true that certain industries and firms will be crushed in bear markets and may take decades to recover. This is part of your due diligence as an investor. During bear markets, strong firms with liquid and bolstered balance sheets should survive any storm and make it out the other side. For firms that are highly leveraged, or have poor cash flow, they will be placed in a tight spot if they are not strong enough to survive a bear market to the fullest.
So this is always something to bear in mind when you are selecting companies for your portfolio.
The main point to take-away from this piece today is that, it is often the case that time in the market is superior to timing the market.
That does it for today’s podcast
I will see you tomorrow for Crowdstrike’s Q2 earnings report.
IT
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