Bear markets can hurt emotionally—a lot. Fisher Investments UK’s chairman, Ken Fisher, often calls the equity market The Great Humiliator (TGH). And TGH likes nothing more than scaring as many people out of as many dollars for as long as it can—before prices go up (or down). We believe a bear market is TGH at its absolute deadliest.
TGH deprives people of market returns any way it can. First, in a bear market your financial portfolio can be down significantly, with huge unrealized losses. Emotions such as humiliation, fear, and agony may come into the picture. Also, TGH knows people hate market losses more than they love gains—a principle called “myopic loss aversion.” Therefore, bear markets are so painful they can make investors go against their strategy and do crazy things that ultimately hurt them—for most of them, much worse in the long term than if they simply did nothing. Things like panic selling at the absolute low. Far too many investors, on their own, do this to their detriment—often in the name of “waiting for clarity,” or suddenly deciding they don’t have the risk tolerance for big equity volatility anymore and change their long-term strategy to invest in a bunch of cash and fixed interest securities, right in time to miss the huge equity market bounce off the bottom.
Another variation: Some investors say they’ll stick with investing in equities until they “breakeven” or hit some other arbitrary milestone, and then they’ll change their strategy—hold cash and fixed interest securities because “fixed interest securities are safer.” But if they think equities are the right asset to get the growth they need to return to their portfolio high (or other arbitrary level) in the near term, then why don’t they think equities can get superior growth longer term? Short-term goals imply a short investment time horizon, for which equities, by themselves, are less appropriate. Longer-term goals imply a longer time horizon, for which equities are—more often than not—most appropriate. Some investors have trouble thinking this through.
If you have a long investment time horizon and goals requiring equity-like growth, a down-market doesn’t change how you should invest. What prudent investors fear is being in a hole they can’t get out of. They know if equities drop 25 percent, it doesn’t take a 25 percent market up-move to breakeven—it takes 33 percent. It takes nearly 43 percent to recover from a 30 percent drop. And if there is a huge market downturn, as there was from during the 2008-2009 financial crisis, it takes a large move just to get to breakeven, not to mention getting any real growth from there. And after all the problems emerge during the bear market, they have a difficult time believing equities can rally that much—TGH at work again. It never changes.
However, this type of market return is far from impossible. Bear markets are a normal occurrence. Sometimes they’re bigger than others are—but through history, equities prices fall—even hugely—then recover and hit new highs again and outperform. A useful way for investors to think about this is if bear markets were unrecoverable, equities prices would only fall—but they don’t. They rise more than they fall, and over time have kept marching higher.[i] That isn’t always true, but usually is. Even if it isn’t, investors are better off with whatever subsequent bull market returns they can get than if they sell-off the market at the bottom and stagnate in cash.
Often when investors are in the midst of a down-market they think, it must be different this time and that equities will never recover, or if they do then it will take years to get back to where their portfolio use to be. But as Sir John Templeton (well-known investor, fund manager and philanthropist) tells us, the “four most dangerous words” in investing are “It’s different this time.” The truth is it’s almost never different this time in any basic way. Yes, details differ, but the fundamentals driving equities and the economy don’t. And human behaviour is pretty predictable in the way we react to bear market fright. So over long periods, equities should keep rising overall, with intermittent downside market volatility, big and small.
Remember: The future includes unknown earnings from yet-to-be-invented products and services born of human ingenuity, innovation, and desires. If you’re putting together an investment strategy with long-term capital, I suggest you bet on the side of it not being much, if any, different this time—despite it always feeling different.
One reason investors fear bear markets are too difficult to recover from is they’re fooled by averages. Let’s say that you assume that average equity returns are about 10% a year. If you need a 33 percent, 45 percent, or 140 percent portfolio appreciation to get back to even, that seems like it would take a really, really long time. Except the equity market’s long-term average includes bear markets. Just as equities can be down a lot—like during a bear—they can be up a lot too.
Bull market investment returns are inherently above average, they have to be to make up for the bear markets. Exhibit 1 below shows returns for US bull markets since 1926, excluding the current bull market. On average, US bull market returns annualize 21 percent. And though duration varies wildly, they can last much longer than many may think, meaning the losses that occurred during a bear can be made up for in a shorter time than many investors assume.
Exhibit 1: Bull Market Returns—Inherently Above Average
*For duration, a month equals 30.5 days.
Source: Global Financial Data, Inc., S&P 500 price return
Presented in terms of US dollars. Currency fluctuations between the dollar and British pounds may result in higher or lower investment returns. The annualised return is a calculation of the yearly return that would result in the actual return for each of the time periods. The cumulative return is a calculation of the market’s aggregate returns.
Investors may think, “Well, I went through that big bear market and am down big. Now I need to change my strategy to hold mostly cash and fixed interest securities because investing in equities is too risky.” But looking backward at the economy tells you nothing about what happens next. Investors should look forward, always, and consider their longer-term investment goals and time horizon, free from TGH’s bear market fears. Don’t be fooled by averages. Bear markets can be big, but bull markets have historically been longer and stronger and we believe they likely will be as prevalent in our future as in our past.
[i] Factset, as of 26/03/2018.