After two years, the bear is back. That means it’s time to review three things every investor should know about how to take advantage – that’s right, advantage – of this bear market.
As you probably know, a bear market is a 20% drop from a recent peak. In this case, the recent peak was on January 3, when the S&P 500 closed at 4,796 points.1 As I write this on October 12, the S&P sits at 3,598. That’s a drop of 24.9%. Bear markets can be a nerve-wracking time for investors, but they can also be an opportunity if you know these three things about them.
The cause of the current bear market.
The first thing to know is why we’re in a bear market. As human beings, we fear things we don’t know, so understanding the cause of a bear market can make the situation seem less scary. That, in turn, helps us make decisions that are more rational and less emotional.
This current bear is primarily driven by overall uncertainty about two things: inflation and interest rates. As inflation has gotten continually worse over the past year, the Federal Reserve has started raising interest rates to bring prices down. In September, the Fed raised interest rates by another .75% reaching the highest rate we've seen since 2008 with no plans to slow down until inflation cools off. The reason the markets are down so much is because investors are afraid that the combination of high current inflation (a direct consequence of the government's Covid response) and rising rates (the government's remedy for inflation - see a pattern here?), might push the U.S. economy into a recession.
Uncertainty causes many people to react with fear, which results in selling and moving towards assets they perceive to be safer than the stock market (mainly bonds and cash - which during rising inflation/interest rate times are really not "safe" at all). That’s essentially what a bear market is – investors making a fear-based decision based on something that might happen in the future. This selling drives down stock prices temporarily, but doesn't mean that the underlying companies are actually less profitable. Their earnings are a more accurate reflection of their true value, which will be reflected once the temporary fear and uncertainty settles down.
This uncertainty has also been aggravated by the fact that we are in a Midterm Election year - which is consistently the most volatile year in a Presidential term. For example, look at the historical average of how the S&P 500 performs during all other years vs. midterm election years:
Sources: Capital Group, RIMES, Standard & Poor’s. As of 8/31/18. Results in USD.
Look familiar? The year-to-date chart of the S&P 500 looks very similar to an exaggerated version of the blue line on this chart. Notice, however, November and December. 9 out of 10 times, the last quarter of a midterm election year starts a recovery, which continues into the next two quarters.2
Which brings us to the second thing to know: What happens after a bear market. It’s called a recovery.
Bear markets are temporary.
No two bear markets are the same. They’re all caused by different factors. Some predate recessions and others don’t. Some can last a few months; others can last over a year. But they are all temporary.
Measured from when the S&P 500 hits a 20% decline, bear markets last an average of 95 days.3 Of course, bear markets that come with recessions typically last longer, but historically, the markets have always rebounded sooner or later. Now, as you know, past performance is no guarantee of future results. But history does often serve as a handy guide. With that in mind, here’s the recent history of how the markets have performed between 1 and 12 months after a bear market.4
Bear market start date | 1 month later | 3 months later | 6 months later | 1 year later |
October 21, 1957 | 3.4% | 5.5% | 9.7% | 31.0% |
May 27, 1962 | -2.0% | 5.9% | 11.9% | 23.1% |
August 29, 1966 | 2.4% | 7.9% | 17.6% | 24.6% |
January 29, 1970 | 4.4% | -4.5% | -8.9% | 11.8% |
November 27, 1973 | 2.1% | 0.7% | -7.4% | -26.9% |
February 22, 1982 | 1.1% | 3.0% | 1.3% | 30.4% |
October 19, 1987 | 6.8% | 10.9% | 14.7% | 23.2% |
March 12, 2001 | 0.3% | 6.4% | -7.4% | -1.2% |
July 10, 2002 | -1.3% | -12.7% | 0.8% | 7.4% |
July 9, 2008 | 4.1% | -26.9% | -28.5% | -29.1% |
February 23, 2009 | 10.7% | 19.3% | 38.0% | 47.3% |
March 12, 2020 | 12.5% | 22.6% | 34.7% | 59.0% |
Again, there’s no way to know what the immediate future holds for this current bear market. What we do know, however, is that the recovery can be one of the most fruitful time periods for investors – because you’re essentially getting in on the ground floor of the next bull market. As you can see, one year after a bear, the markets often will have recovered what they lost and sometimes gone on to new heights! But there’s only one way to take advantage of these types of potential gains:
The key to turning a bear market to your advantage is patience and discipline.
You know people often say how they wish they had a time machine so they could “go back and invest in Company X?” Well, take any high-performing company you want. Early investors in that company had to show patience and discipline before they could ever reap the rewards. The good news is that we don’t need a time machine. All we need is the patience and discipline to treat your portfolio as what it is: a long-term investment in your long-term future.
Last, but not least, we'll leave you with a quote from an investor whose reaped the rewards of patience through his share of bear markets, Warren Buffet 5:
Additional Sources:
1 “S&P 500 Historical Prices,” The Wall Street Journal, https://www.wsj.com/market-data/quotes/index/SPX/historical-prices
2 "3 Ways the Midterm Elections Could Impact the Stock Market", Forbes, https://www.forbes.com/advisor/investing/midterm-elections-stock-market/
3 “Here’s How Long It Takes For Stocks to Recover From Bear Markets,” Forbes, https://www.forbes.com/sites/sergeiklebnikov/2022/05/23/heres-how-long-it-takes-for-stocks-to-recover-frombear-markets/?sh=655019002565
4 “How the S&P 500 Performs After Closing in a Bear Market,” The Wall Street Journal, https://www.wsj.com/livecoverage/stock-market-today-dow-jones-bitcoin-fed-rates-06-14-2022/card/howthe-s-p-500-performs-after-closing-in-a-bear-market-yBwgfJwW8HGSNJaKg6LB
5 "42 Warren Buffet Quotes for Intelligent Investors", Investment U, https://investmentu.com/warren-buffett-quotes/