Bear markets are often viewed negatively, but they’re part of a normal market cycle. Recognizing and understanding bear markets can put you in a better position to make strategic investment decisions when they come around.
Understand how bear and bull markets have performed on average to approach bear market investing more strategically
Part of successful bear market investing is avoiding errors that can weaken your portfolio
There’s something counterintuitive about investing in a bear market. When you jump into a plunging market, you have to be willing to embrace the likelihood of further losses before you may see potentially greater returns when the bear finally yields to the bull. It’s a hard pill to swallow. Many investors just can’t do it. And as a result, they might miss out on the opportunity to buy low.
We’ve all heard the saying“don’t catch a falling knife.” As wise as this may sound, it doesn’t help much when the bear rears its ugly head. That’s because in a bear market, it could be raining knives for quite some time. There’s an upside, though: a falling stock is only a proverbial knife if you catch it the wrong way.
When markets fall, you want to catch as many high-value yet discounted stocks as possible without hurting yourself in the process. So how do you position yourself for the next bull market without getting mauled by the big bad bear?
Before you set out to engage this dangerous beast, it might help to better understand what you’re tracking. Let’s go over a few basics.
A bear market is a fundamentally driven market decline of 20% or more. A bear market often coincides with a weakening economy, massive liquidation of securities, and widespread investor fear and pessimism. As you’ve probably figured out, a bear market is quite different from a bull market.
According to CFRA data on the S&P 500, we’ve had roughly 12 bear markets from the 1940s to the present, not including the current market conditions. The shortest stock market bears lasted for around three months in 1987 and 1990. The longest bear stayed around for three years, from 1946 to 1949. Taking all 12 past bear markets into consideration, the average length of a bear market lasted around 14 months.
The shallowest bear market loss took place in 1990, when the S&P 500 lost around 20%. The deepest by far happened during the financial crisis between 2007 and 2009. We saw the S&P 500 lose approximately 59% of its value in about 27 months. On average, bear markets past have shown a drop of -34%. Keep in mind that any particular bear decline can be lesser or greater than the average.
There’s no way to predict the outcome of any market cycle. But you can look at the historical averages. Assume the current bull market ended on March 11, 2020 when the S&P 500 breached the -20% level, closing below 2708 versus its February close of 3386.
Compare an average of 14 bearish months with 60 bullish months, and a -33% decline with a 165% rise (on average). If anything, history seems to have favored the bulls in the broader U.S. stock market.
This doesn’t mean a bear market won’t hurt your portfolio. And you could still make some serious investing blunders, such as unsuccessfully timing the market, selling your stocks at a loss once you’re in a bear market, and failing to invest at the beginning of the next bull. (Remember, there is no guarantee every stock may recover. All companies run the risk of failure.)
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Going “all in” means throwing your entire stake into a single bet. If you’re lucky, then winner winner chicken dinner. If you’re not lucky, you lose all your buying power, plus you’ve got a string of painful losses ahead.
The problem with a bear market is that you can never tell whether you’re at the beginning, middle, or end of it. Imagine putting all of your investable funds into a bear market that just got underway. You have several months to go (you just don’t know it yet).
What are you going to do when you see your entire portfolio losing value sharply and consistently for several months? Are you going to sell it all at a massive loss?
Don’t “go big or go home” if it means losing your home, figuratively speaking. Investing is about taking calculated risks, not betting on a lucky hand. So, what might you consider doing instead?
Suppose you decide the current market declines suggest we’re in a bear economy and not a mere correction. Say you want to begin snatching up discounted shares of strong companies. The thing is, you don’t know how long or deep the bear market will go.
Instead of going all in at once, you might consider buying small chunks at a time, a strategy called dollar-cost averaging. Based on your current savings and income, what small percentage can you afford to invest—2%, 5%, 10%, or more?
Of course, once you begin investing, don’t expect to see immediate returns in the midst of a bear market. Instead, focus on positioning your portfolio for the next bull.
Although most stocks and sectors may fall during a bear cycle, some will buck the trend. And once the bear market ends, stocks in certain sectors may jump ahead of others. Should you try to pick winners? Unfortunately, sector rotation isn’t easy to predict. So, how might you benefit from potential stock or sector winners? That brings us to the next point.
When you buy a stock, you own the risk and growth potential of that business. If the business performs well, your shares rise in value. If not, well, your share values sink. If you concentrate your holdings on stocks in a single industry or sector, the same principle applies but on a larger scale. Hence, the value of diversification. Interestingly enough, you can actually diversify your portfolio with as few as 12 stocks, unless you decide instead to buy sector or broad market exchange-traded funds (ETFs).
When you diversify your holdings to target stocks in all 11 sectors, you end up casting a wide net. Although diversification does not eliminate the risk of experiencing investment losses, it can help you increase your chances of capturing better-performing assets and avoid the risk of losing your overall portfolio value to any single business, industry, or sector. Again, during a bear economy, most stocks tend to fall; that’s to be expected. Remember that you’re looking to position your portfolio for a coming bull and using the bear to potentially give you a preparatory boost in discounted stocks.
Some analysts have argued that the tail end of a bear market is characterized by the steepest levels of panic selling.
So, might this extreme end of market pessimism shine the “go” light for investors? If you’re dollar-cost averaging carefully, the green light may always be on. But many investors miss the start of bull markets by staying out because of fear, or they may attempt to time the market (which often doesn’t work out). Remember, your time in the market is more important than timing the market.
When a bear strikes, you can see share prices falling hard and market values getting lower. Mentally, this may trigger your sense to “buy low,” which is generally a smart thing to do. But emotionally, it’s hard to hold on to assets that are losing value for weeks or months at a time.
Exercise prudence and patience and keep a strategic eye on downtrodden yet valuable assets. A bear market may not be a time to reap gains, but it’s arguably a great time to sow the seeds for the next bullish season.
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