I wish all investors get at least one bear market in their investing journeys. A lot of people would consider this a curse—but it really is a blessing in disguise. I will explain why.
Today, financial media is focused on when this bull market will end. As if the end of a bull market (and beginning of a bear market) is somehow the end of the world. It is as if avoiding a bear market is the best thing an investor could do for himself.
I admit that it would be great if I could detect the onset of a bear market and sell my stock holdings before they go down in a downturn. But this would only be just one side of the coin. I better be able to then identify when the market bottoms so I could buy back stocks in time. Failing to detect the beginning of a bear market wouldn’t be good because then I’d have to endure seeing losses (even if they are just on paper). However, failing to get back into stocks in time would be much more disastrous for my portfolio. Why? Because every bear market is followed by a bull market.
So, in order to pull off this bear-market avoidance maneuver, I need to make two accurate predictions—not just one. First, when to get out of stocks and then when to re-enter the stock market. I don’t think I have it in me!
Two years ago, in November 2017, I wrote in a blog post how media headlines of the time were projecting imminent doom. An ex-senator, a hedge-fund billionaire, a book author—they all had expressed concern that a market plunge could come soon. If I were taking cues from those prevalent media stories—those were headlines from CNN, CNBC, and MarketWatch, no less—I probably would have gotten out of the market back then. Who knows when I would have gotten back in, if at all. Certainly, the media today continues to be not too enthused about the market’s future. And yet, the S&P 500 is up about 15% since I wrote that post. And I am not even counting dividends.
It’s not just the media, most market experts can’t accurately predict market declines and recoveries. History shows it. CXO Advisory group tallied on-record predictions from sixty eight different market experts over a seven-year period. The most accurate predictor of them all was no better than just 68% right.
So, when experts are not much better than regular media, what an investor got to do? The straightforward answer—and the one I practice—is to stay invested. Bear market or not. That means my portfolio will see declines from time to time. Sure. To me, this is the price to play this investing game successfully over the long run.
Portfolio declines are inevitable part of an investor’s journey. Warren Buffett has famously said once that:
You shouldn’t own common stocks if a 50% decrease in their value in a short period of time would cause you acute distress.
He was referring to single-company stocks that tend to be more volatile. If I am holding a collection of various stocks (or a broad market index), my portfolio would be less volatile. And because I keep some dry powder cash and other less-correlated asset types (for instance, real estate and income generating stock options), I believe my portfolio likely won’t go down by 50% in the next bear market. But it will go down, for sure. To avoid anchoring myself to a single number (that might turn out to be a high point for an extended period), I think of my portfolio value in ranges. As I explained in this blog post, today I consider my range to be plus-minus 25%.
Warren Buffett also pointed out in his 2018 shareholder letter that his company’s stock—Berkshire Hathaway (BRK.A, BRK.B)—has dropped by 50% three times in its history so far. There will likely be more such drops in future too. This is how investing works over the long term.
Going through a bear market while keeping faith in the long-term compounding of stocks can be difficult—no question. But it also teaches us a lifetime’s worth of lessons. Lessons that can be very profitable for the rest of our saving/investing journey. This is why I say that a bear market could indeed be a blessing in disguise.
I consider myself fortunate to have gone through two bear markets as an investor. I chronicled my investing journey through a twenty-year period in a 401(K) here. That time period spanned both the 2000-02 and the 2008-09 bear markets. One major lesson I learned from that experience is how profitable it is to buy stocks when they are unloved. As you can see from this chart, that 401(K) account had dropped in value with each market decline but then rose strongly as soon as the market turned. Both times as the market recovered from its trough, my account value quickly reached a new high—well before the market itself had fully recovered. I was dollar-cost indexing into the market throughout.
What if we suspend disbelief for a moment and imagine a scenario where stocks crash and never recover? A researcher who writes under the pseudonym Jesse Livermore ran numbers and showed that a 66% market crash would be more profitable than a 200% market rise for an investor who has thirty years to invest. As long as she reinvests all her dividends throughout the period. I wrote about it in this post: What if I had invested near the stock market peak?
Another lesson I learned from the two bear markets was how stocks eventually recovered. No matter how steep each decline was. And those two bear markets went very deep—about 50% each time. Those were what an AAII author called “Mega Meltdown” bear markets. Since 1940, there had only been three such meltdowns in total. See this chart. Ordinary or “Garden Variety” bear markets only drop about 25% on average from their peaks. Even when faced with two near back-to-back mega meltdowns, it was very profitable to hold on to stocks. Even better, buy more with new money. I did both and came out well.
It really isn’t a surprise that investors who hold on when the market is tanking do well. Stocks are partial ownerships in businesses. And recessions are few and shorter than economic expansions. As the GDP starts growing again, businesses also recover their profits and grow again. They always do. We investors need to be patient and only invest what we won’t need for another five years or so. And perhaps more importantly, don’t succumb to media induced panic.
This brings me to another lesson learned from the experience: financial media’s failure to forecast. In 2009, if I were looking for any sign when the market would stop declining, I sure wouldn’t have found it in the mainstream press. In fact, throughout the 2008-2012 period, the media was full of stories about how dire our economic prospects were. I wrote about this prevalent pessimism in previous blog posts. For instance, a journalist declaring in 2010 that “stocks are dangerous things to own.” A venture capitalist who spelled out six reasons why he doesn’t invest in the US stock market anymore. Authors of a financial planning book who recommended in 2011 against owning any stocks. A highly regarded investment manager who predicted in 2009 that stocks won’t deliver better returns than bonds.
Financial media reflects prevailing sentiments, so it is not surprising that it will project pessimism in the wake of a large bear market. In the same vein, the media was largely bullish immediately preceding the 2000-2002 market decline. Stocks, back then, were coming off a long bullish run. People were feeling very optimistic about investing at the time.
It’s a blessing to have gone through the last two bear markets. Each bear market is unique in its nature. What might cause the next bear market could be very different than what led to the previous one. It might be shallower and shorter. Or it could be deeper and longer. I don’t know. However, we can count on some things to remain the same. A future bear market will give way to another bull market. And I, as an investor, will see my portfolio first recover and then grow to new heights. So long as I stay even keel and keep on investing. And finally, popular media will continue to be of no particular help in detecting a change in market direction.