Bear Market In Stocks
A bear market in stocks is now within sniffing distance.
Stocks are said to be technically in a bear market when prices fall 20% from their 52 week high and when the price of investments fall over time. It is when stocks prices make lower highs and lower lows over time. So the S&P 500 will technically be in a bear market when it falls 20% from its high of 2872.87 (which it reached January 26).
Who are the wins and losers in a bear market in stocks?
A bear market in stocks is a type of wealth transfer to younger investors with a longer investment time-frame. Put another way, a bear market enables millennial to build a stock portfolio of value stocks at “sensible prices”. But it is those investors nearing retirement, the baby boomers with a shorter investment time-frame that are more vulnerable to bear markets, bearing in mind that a bear market lasts an average of 367 days.
So let’s put this into perspective, a bear market in stocks doesn’t mean the end of the system or some great reset. In reality, bear markets are not unusual, they are part of a healthy market cycle and occur frequently. From 1900-2014, there were 32 bear markets. Statistically, they occur about 1 out of every 3.5 years and last an average of 367 days.
However, a bear market’s nutrition is capital and it feasts on leveraged investors/traders who try and call a bottom price level as stocks keep falling to lower lows every time. So leveraged long (buy) traders (with not so deep pockets and short time frames) make a moveable feast for bears. The buy low sell high mantra doesn’t work in a bear market.
Moreover, it can be particularly disastrous for inexperienced traders/speculators who fund buy positions with margins (credit).
It is a pity the 24-year-old financial analyst didn’t read my piece, “Financial Smash Up Heading Our Way” before placing his bet.
Market timing is the world’s most sophisticated form of gambling. When I make a good call I keep reminding myself that maybe I am just a lucky idiot-that stops me from going all in and one day blowing my account up when I get it wrong.
There is a difference between speculating, using a little bit of money (leveraged trading) with the aim of making a lot of fast money and long-term investing using a lot more money to make steady gains over a longer time frame. So long-term investors don’t have to worry too much about market timing since secular bear markets eventually end. But if stocks are entering a bear market it is always more profitable to buy value stocks at their bottom price level.
So how low can stocks sink in a bear market?
Buckle up because if the historical charts are anything to go by stocks could be heading for significant falls. For example, in the 1930’s stocks dropped 86% over 39 months. In the 1970’s the market dropped 48% over 19 months and the most recent bear market in the US occurred in 2007-2009 when the stock market dropped 57% over 17 months.
Japan’s bear market “Lost Two Decades” from 1998 to present where market values were noted as having declined 80%.
Now here is the good news, the year after the bear market is a boom period, according to the charts.
In the year after the three previous 20%+ tumbles, the S&P 500 Stock index rallied an average of +32%. But you have to be willing to stay invested in the market during the down times (that means brushing off all the doom and gloom predictions) to participate in the recovery.
How to invest in a bear market?
Keep cash on the sideline so that you are able to take advantage of buying opportunities as and when they arise. Market timing is difficult, so use fundamental analysis to gauge stock market opportunities. Invest with a long time frame and avoid using credit.
Consider using the P/E Ratio to value stocks which is the ratio of the market price of a company’s stock to its earnings per share (EPS):
The long-term average P/E for the S&P 500 is around 15x.
Also, keep a diversified portfolio of bonds and stocks. If your aim is high returns and your tolerance to risk is high than 100% in stocks. A moderate aggressive allocation would be 80% in stocks and 20% in bonds. A conservative allocation would be less than 50% in stocks if your main goal is capital preservation rather than higher returns.
If you are in retirements then it is recommended that you invest what you don’t need in stocks for at least five to ten years.
See also a solid dividend in good and bad times.
Does a bear market in stocks lead to an economic recession?
Surprisingly not all previous bear markets in stocks led to a recession. For example, the bear market of 1955 followed an economic boom. Likewise, the 1962 JFK bear market was also a period of economic prosperity and the 1987 crash “bear market” lasted 38 days and the economy grew 3.5% in 1987.
But there are a few big differences today. The current debt to GDP ratio is more than double what it was in 1987 and 1962.
Moreover, inflation is currently trending upwards and the Fed is set to raise rates three times in 2018, as it did last year. The longest period of near-zero interest rates policy is coming to an end. So too are the zombie companies (with no real profitable business models) that were kept alive on an artificial life-support of cheap credit. How different will the economic landscape look when the Fed normalizes interest rates?
The widening spreads on the credit market is also a sign of economic uncertainty.
So this imminent bear market in stocks could be nasty.