A Bear Market Primer
A Bear Market Primer
We are currently suffering through a bear market, and investors are bracing for a potential recession. As losses mount, some investors are questioning their investment portfolios and long-term financial plans.
It is a pivotal time. If you make the wrong move, you could put into jeopardy the very plans you are trying so hard to protect. It’s a good time to revisit some foundational advice that has sustained smart investors through many bear markets and recessions.
Shortly after I founded my firm in 2010, I attended a small conference in Santa Monica, California, hosted by Dimensional Funds where I met Nick Murray. Nick is the author of 13 books about investing. He had a long career as a financial advisor and professional investor. He is now an advisor to financial advisors.
Nick had navigated a lot of difficult markets and had some sage advice for financial advisors like me. In 2007, he received the Malcolm S. Forbes Public Awareness Award for Excellence in Advancing Financial Understanding.
What Nick said during that conference really resonated with me. In this newsletter, I want to impart to you the advice he gave to me and a handful of other financial advisors as we struggled to shepherd clients through the aftermath of the Great Recession.
Here are four timeless pieces of advice from Nick Murray:[1]
“Wealth is not determined by investment performance but by investor behavior.”?
Study after study shows that investor behavior is the primary driver of the success, or failure, of individual investors – not security selection, not market timing, not even portfolio design. The truth is that far too many investors panic during bear markets and make rash decisions, dramatically reducing their chances of reaching their long-term investment goals.
Decisions like the following: “I’m going to the sidelines while this thing blows over.” This sounds so reasonable and simple, but there are so many problems with this decision.
First, when this investor “goes to the sidelines,” the market has already gone down substantially. They are essentially selling at or near the bottom, locking in losses. Mistake number one.
Second, while this investor waits until things “blow over,” they will likely miss the robust recovery that inevitably follows a downturn. Markets typically start to rise during a recession, not when it’s over. Even so, these investors won’t get back in. They believe the recent rise must be a “head fake” or we are heading for a “double dip.” By the time they finally get back into the market when the “coast is clear,” it is near the top of the next cycle when assets are becoming overvalued again. Mistake number two.
History shows us a few things.[2]
First, bear markets are followed by robust recoveries that drive the markets even higher.?
Second, these recoveries occur well before “the coast is clear.”
Third, markets are forward looking and tend to move well in advance of positive developments.?
If you don’t believe me, look at Exhibit C: A History of Market Ups and Downs, Exhibit D: History Shows that Stock Gains Can Add Up after Big Declines, and Exhibit E: Market Returns through a Century of Recessions. These exhibits show how the markets have recovered in the past. If you wait until the recession is over to get back into the market, you are too late.
Note: For the exhibits, please see the full newsletter on my website here: www.lewiswm.com. The newsletter is located on the bottom of the homepage.
Recommendations
Don’t panic. Although no one can say for sure, there will likely be a robust recovery from this bear market – just like all the others. As you will see, there have been 17 bear markets since WWII. In each case, the market recovered and went on to reach new highs. It would be unwise to bet against the weight of this history.
The recovery will occur long before the problems we face today are resolved – long before inflation goes back down to 2%, gas is $3 a gallon, and the war in Ukraine is over. If you wait for these things to happen, you will likely miss the recovery.
“Bear markets are as common as dirt, get used to them.”
There have been 17 bear markets since the end of WWII – about one every 4.5 years on average. Recessions are also common. There have been 16 of them since 1926 – about one every six years.
When it comes to the frequency of bear markets, Nick says: “If you work and accumulate capital for 40 years, on average you’re going to go through eight of them, and if you and/or your spouse live 30 years in retirement, you’ll get to enjoy six more.” He adds, “[i]n the long run, a bear market really doesn’t matter. The only thing that matters is how investors respond to them.”
Recommendations
Please look at Exhibit A: List of Bear Markets Since WWII and Exhibit B: List of Recessions Since 1926.
Note: For the exhibits, please see the full newsletter on my website here: www.lewiswm.com. The newsletter is located on the bottom of the homepage.
Study these exhibits carefully. Now, take your birth year and compare it to those lists. How many bear markets and recessions have you already survived? I have been alive for 14 bear markets and eight recessions. I have been an investor during nine bear markets and four recessions. How about you?
As you can see, we have recovered from each bear market and recession that we have ever faced. In each of those events, we faced serious problems and challenges – many of which were more serious than those we face today. Yet, we overcame them all. The market recovered and went on to reach new highs.
While none of us can predict what exactly will happen next, I believe that the recovery to this bear market is sitting out there waiting for the patient and disciplined investor.
“No bear market is unique, none is fatal, and this time is never different.”
Nick points out that “[t]he world does not end; it only appears to be ending from time to time. No bear market is unique, none has ever been fatal.” He is also critical of the catastrophist, someone who is advocating the apocalypse du jour and the imminent demise of the world.
The problem with catastrophists is what they believe goes directly against the weight of history. They cannot distinguish between what is possible (which is almost anything) and what is probable (which is a range of likely outcomes). Successful equity investing is based on historical probabilities, not remote catastrophist possibilities.
The world is constantly beset by problems. Those problems invariably get solved only to be replaced by new ones.
These problems include but are not limited to wars, famine, disease, drought, inflation, unemployment, deflation, defaults, bankruptcies, foreclosures, business failures, accounting scandals, legal risks, deficit spending, central bank errors, fiscal policy errors, overleverage, collapsing credit markets, rising interest rates, volatile commodities prices, reckless speculation, hurricanes, fires, terrorist attacks, assassinations, gun violence, crime, climate change, regulatory risk, political risk, fraud, investment swindles, lower corporate earnings, revolutions, coups, panics, taxes, tariffs, and any other reason you can think of.
We have experienced them all, and we have solved them all. They come back again and again. Then we solve them again and again. That is why this time is not different.
This is how the world works. We sometimes forget all the hardships we have faced and problems we have solved. It is not our nature to pause and celebrate our successes – we are already focused on the next urgent, apparently unsolvable problem.
The catastrophist casts the weight of all this history aside. They believe this time is different. It must be worse. It must be intractable. It is the end of the capital markets and Western civilization as we know them.
Today’s media do not help. Rather than putting today’s challenges into proper perspective, “journalists arrive to isolate whatever is wrong at the current time, extrapolate it – and make things appear much worse than they really are,” says Nick.?And he’s right.
Recommendations
This bear market is not unique. It is not fatal. And this time is definitely not different.?
We have faced down inflation in the past, like in 1980 when inflation reached 13.5% (much worse than today). We dealt with surging energy prices in 1973 during the Arab Oil Embargo (much worse than today). We have dealt with many wars and conflicts such as WWI, WWII, the Korean War, Vietnam, Iraq, Afghanistan, and the attacks on 9/11 (all more serious than the war in Ukraine at this time).
We have been here many times before. Markets crash and then recover to reach new highs.
As for the media, remember that today’s journalists and pundits are entertainers with their own sponsors, networks, and viewership metrics. These people cannot look out for your best interests – they don’t even know you.
The catastrophist struggles to put today’s problems and challenges into the proper perspective, and this can sometimes lead to panic. Resist heading down this path. Patience, not panic, is the order of the day. This too shall pass.
“Bear markets are a temporary interruption of a permanent uptrend.”
In 1946, the S&P 500 bear market trough was 13.6. As I write, the S&P 500 bear market sits at 3,799.5. That is an increase of 280 times! The long-term trend of the markets is decidedly up – there is no doubt about it.
The average annual return of the S&P 500 Index from 1926 to 2021 was 10.5%. The average annual return of the Bloomberg US Aggregate Bond Index from 1976 to 2021 was?7.1%.[3]?
This is the financial engine that allows you to save, invest, and grow your money so that you can achieve your long-term financial goals. But to earn these returns, you must be constantly invested in the market.
Bear markets appear from time to time, largely because of human nature. We tend to overshoot valuations at the top of a cycle and undershoot them at the bottom. But bear markets are the reason that investors are paid a premium for investing in stocks because they are putting their capital at risk of loss in the short run. If there were no bear markets, there would be no risk premium – no long-term returns higher than the CD rate offered at your local bank.
As Nick says, “[a] bear market is a period of time during which common stocks are returned to their rightful owners.”
Our system of capitalism remains dynamic. There are tremendous incentives, financial and otherwise, to successfully develop and implement new technologies to solve today’s problems. Optimistic and industrious people are hard at work as you read this – you may be one of them. The companies they form to take on these problems are tomorrow’s investment opportunities that will drive returns for years to come. Fortunately, we can invest our money with these optimistic people and they can help us make our long-term financial goals and dreams a reality.
In 1899, Charles Duell, commissioner of the U.S. Patent Office, famously said that “[e]verything that can be invented has been invented.” He could not have been more wrong.
According to Time magazine, these are the 20 most important inventions of the 20th century: the automobile, radio, television, the transistor, the laser, electric refrigeration, the personal computer, wireless technology, manned spaceflight, the airplane, radar, magnetic tape, plastics, air conditioning, global networks, the atomic bomb, artificial intelligence, fiber optics, xerography, and the Internet.
And in the 21st century, so far, we have artificial intelligence, virtual reality, smartphones, capsule endoscopy, e-readers, driverless cars, and so on.
Despite today’s negativity, the real pace of progress is upward and accelerating – not the other way around.
Recommendations
Right now, it seems like we have a lot of intractable problems, and they are serious, but we have faced far greater challenges in the past. After going through this pandemic, I think we underestimate our potential. In my view, the catastrophist is today’s Charles Duell.
The weight of history is behind the optimist. I recently watched a series on television called “Chasing the Moon.” It documented the space program from its inception to Apollo 11, which put Neil Armstrong and Buzz Aldrin on the moon. Our space program was built by optimists with courage and slide rules. In the show, Aldrin marveled at the capabilities of his own smartphone, which has 100,000 times more computing power than the computer on Apollo 11. That’s what progress looks like.
In the capital markets, just look at what Warren Buffet is up to lately. He’s buying stock – lots of stock. He knows that stocks are on sale right now. He is not shrinking from making an investment in the future of our economy, our country, and the world.
Panic is your worst enemy. If you have a sound investment portfolio, I encourage you to simply stay the course.?
If you have questions about your portfolio or your long-term financial plan, give us a call or reach out to a competent financial advisor.
I hope this newsletter finds you safe and well. Please reach out with your investment questions and concerns.
Thank you.
D. Austin Lewis
This is an educational newsletter expressing opinions only. This newsletter should not be relied upon until your individual situation is taken into consideration by an experienced advisor. This newsletter is not designed or intended to give you individual investment, tax, or legal advice. We strongly recommend that you consult with your own financial/tax advisor and/or legal counsel for information and advice concerning your particular situation. If you are a client, please give us a call. Past performance does not indicate or guarantee future results. Investing involves substantial risks, including loss of principal.
[1] Nick Murray has written one book for individual investors: Simple Wealth, Inevitable Wealth (20th Anniversary Edition,), 2019. Most of the quotations presented here come from Nick’s book Behavioral Investment Counseling, 2008 (particularly, Chapter 12: “Bear Markets, An Appreciation”). Nick’s books and other materials can be found on his website: www.nickmurray.com.
[2] Here I must add the ubiquitous “past performance is no guarantee of future results.” Personally, I believe that history provides valuable perspective for the problems, challenges, and tumult of today, but it is not an accurate predictor of what will happen in the future or when.
[3] DFA Matrix Book 2021, pp. 16, 40.