Learning from past bear markets can take teeth out of current downturn

As a Canadian, you probably know what to do if you encounter a bear in the woods: keep your cool.

It turns out this advice can serve you equally well when navigating a bear market. But in the throes of market declines, even the most seasoned investors can fall victim to the natural responses of fear and panic. In both scenarios, these knee-jerk reactions are unlikely to end well.

Despite the short-term uncertainty that inevitably accompanies a bear market, it can be helpful to remind yourself of long-term data and market trends. Economies and the markets move in cycles, and while catalysts change and timelines are never certain, reviewing patterns from the past can help provide context and perhaps some needed peace of mind about the future.

Let’s look at the definition of a bear market, how long they typically last and, most importantly, what an investor can do to come out the other side stronger.

In simple terms, a bear market is a sustained equity market downturn that includes a 20-per-cent fall from previous peaks. Bear markets are usually characterized by elevated volatility levels, increased skepticism and often an economic recession (defined as two quarters of declines in key metrics such as real GDP, real income, manufacturing production, employment and sales).

This graphic outlines all of the U.S. bear markets since the stock market crash of 1929.

Figure 1: A history of U.S. bear markets, ranked by size

Bear markets can be painful, but the good news is that once the market turns, the average bull market runs for 991 days or 2.7 years and, overall, stocks are on the rise about 70 per cent of the time. This is a pretty good deal for investors, particularly if they are prepared to stay in the game. When you’re in the teeth of the bear, though, this is easy to forget.

What to do when you’re face to face with a bear

The most important thing you can do is stay invested through market downturns, as this will help minimize the time it takes your portfolio to recover and ensure that you don’t permanently impair your capital.

If you’re considering trying to time the market – i.e., sell before the market falls further – remember that even if you avoid some pain on the way down, you have to know when to get back in at the bottom. Picking either the top or the bottom of a market is very, very difficult. Picking both is next to impossible.

A closer look at Figure 1 above reveals that significant returns are earned in the first year following the bottom of a bear market. This is a crucial reason why long-term investors should stay invested (and commit additional funds if they can) during bear markets.

In fact, the consequences of not being fully invested when a major market turnaround occurs can be disastrous to your long-term investment goals. A look at the past performance of the S&P 500 Index from 1990 to 2018 shows this dramatically. If you stayed fully invested throughout, your annualized return would have been 9.9 per cent per year. If you missed just the best 30 days out of this 10,000-day timeframe, your annualized return would have dropped to 4.0 per cent per year.

In dollar terms, that means an initial $100,000 investment over the period would grow to just $300,000 instead of $1,500,000!

The opportunity

Bear markets can be discouraging, but here’s how to make the most of an otherwise bad situation: Keep Calm and Carry On. If you are in the position to weather possible further decreases and have cash available to purchase stocks, keep accumulating them while they are at bargain prices, particularly stocks that have strong fundamentals. When the market rebounds, they will, too.

Certain types of companies tend to perform better during and coming out of bear markets:

• Value stocks (stocks with lower price-earnings ratios and greater earnings stability) typically outperform the broad market indices during a bear market. There is generally also an influx of investor capital into these stable, profitable companies when markets eventually turn the corner.
• Growth stocks (those with expected earnings growth and price-earnings ratios higher than the market average) are most susceptible to price declines during market downturns. These richly priced companies, whose values tend to be based more on future profits, are the most likely to fall fast and far in a bear market.

The bottom line

Bear markets are inevitable, but so are their recoveries. If you are an investor and worried about a bear market, remain calm, remember what past market downturns have taught, and consider your own temperament, biases and strengths. As this can be easier said than done, having a skilled and experienced advisor can help guide you along the way.

Leanne Scott, CFA, provides discretionary portfolio management for foundations and wealthy individuals and their families with Leith Wheeler Investment Counsel in Vancouver. With more than 20 years of investment industry experience both in Canada and the UK, Leanne also holds an MBA and the Chartered Financial Analyst (CFA) charter.

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