History and a belief in capitalism tell us the most probable event following a bear market is a bull market
Throughout history, bear markets have bruised investors, testing their ability to stick with their long-term strategies. Seeing dips in your portfolio is never pleasant. Listening to the media and pundits during bear markets can give you the impression that this time capitalism has fundamentally broken down and markets will likely never recover.
Historically, bull markets have gained more than bear markets have declined—were it otherwise, equities would never move higher.[i] Whilst equity market returns over any period vary widely, historically equities have risen over longer periods of time—think 20 to 30 years.[ii] As frustrating as these events might be, patient investors can find solace in the fact that poor short term equity market performance doesn’t necessarily indicate continued poor performance.
Exhibit 1 plots the performance of the S&P 500, a widely referenced American equity market index, over flat or negative decades and the years following. Even the bleakest periods have been followed by positive returns. Whilst no one can say what the future holds with certainty, even significant market declines in the short term don’t mean equities won’t do well in the future.
Source: Fisher Investments Research; FactSet; Global Financial Data Inc., as of 31/03/2016. S&P 500 Index Total Return Level in USD. International currency fluctuations may result in a higher or lower investment return.
Whilst it is easy to believe that bear markets will never end, fortunately capitalism's driving forces are extremely flexible and resilient. Despite financial panics, market declines, regulatory overhauls, flu epidemics and pandemics, wars, social upheaval, presidential assassinations, natural disasters, monetary and fiscal policy mistakes, protectionism, hyperinflation, bubbles (credit, property, equities, etc.), fraud, and a host of other problems along the way, capitalism and the profit motive continue to function. It continues to provide an incentive for individuals to work hard, develop new technologies and innovations, increase productivity, and raise our standards of living. It's impossible to predict exactly what the next innovation will be—imagine sitting in your Dodge Avenger in 1978 listening to an 8-track tape and trying to predict the invention of the internet. However, if you believe in capitalism, then you likely believe innovations will continue, productivity and standards of living will rise because of them, and investing in equities will continue to give you a higher probability of being wealthier than fixed interest or cash over time.
Historically, the longer the time period, the higher the probability equities outperform other asset classes such as fixed interest, and typically by a wider margin.[iii] Therefore the longer your time horizon, the more likely we believe you'll be better off invested in equities most of the time. This is no guarantee—it's simply, in our view, the rational evaluation of probability, and the same reason millions of people get behind the wheel of their car every day despite thousands of daily car crashes, many deadly.
The future is full of uncertainty. So the best you can do is invest based on what's most statistically probable. We believe investing is a probabilities game, not a certainties game. You could instead play a certainties game by owning an asset like cash, but you probably wouldn't be happy with your long-term returns.
No one knows where the equity market is headed tomorrow, next month or even next year. But history and a belief in capitalism tell us the most probable event following a bear market is likely a bull market. Capitalism didn't break. Bear markets are part of the economic cycle—always have been, always will be. A bull market will come.
[i] Global Financial Data, as of 30/07/2018. S&P 500 Index Price Level in USD from 29/05/1946 – 31/12/2013. FactSet, as of 05/02/2018; S&P 500 Index Price Level in USD from 01/01/2014 – 30/07/2018. International currency fluctuations may result in a higher or lower investment return.
[iii] Source: Global Financial Data, Inc (GFD). Average rate of return from 01/01/1926 through 31/12/2017. 5-year and 20-year annualised equity returns are 10.3% and 11.0%, respectively, whilst 5-year and 20-year annualised fixed interest returns are 6.2% and 6.0%, respectively. Equity return based on GFD’s World Return Index in GBP. The World Return Index is based upon GFD calculations of total returns before 1970. These are estimates by GFD to calculate the values of the World Index before 1970 and are not official values. GFD used specified weightings to calculate total returns for the World Index through 1969 and official daily data from 1970 on. Fixed Income return based on GFD’s GFDatabase World Government Bond GDP-weighted Return Index, converted to GB.