You may have the urge to sell your equities, exchange-traded funds (ETFs) or mutual fund holdings during a bear market—a fundamentally driven downturn of over 20%. Despite other potential issues with this action, you will then face a tough question: Now that you’re out, when should you re-invest and get back into the market? Market downturns can be terrifying, but so, too, can missing out on the subsequent rebounds. So is it better to wait until it’s certain the bear market is over, a new bull has begun, and all is clear?
The answer might surprise you. As counterintuitive as it seems, you may be better off re-entering the market before the rebound has occurred. Waiting for certainty comes with a lot of potential opportunity cost, and precisely timing the market is almost always impossible. As painful as the fluctuations and downturn of a late bear market may feel, missing the start of a new bull market can be more costly and may have long-term repercussions. New bull market equity returns are often swift and sharp—countering some of the previous bear market’s late-stage losses.
Think of a bear market like a compressed spring: The more you push down, the bigger it could bounce. Historically, the biggest, sharpest bear market drops happen at the end. At that point, diminishing liquidity—like in the Autumn of 2008 during the financial crisis—and overly dour investor sentiment lead to exaggerated losses and panic. But this late-stage panic is usually sentiment-driven as investors often react emotionally during an extended downturn. Bearish investors tend to assume the temporary lack of liquidity is tied to some other fundamental issue.
When investor sentiment takes a turn for the worst, securities can drop quickly and sharply. But as a new bull market starts, the reverse can happen just as fast—equities zoom higher on sentiment as things aren’t quite as bad as feared and liquidity returns with it. The big initial boom often happens not because things are good or improving, but because they end up being not quite as much of a disaster as assumed in the panic. You can think of this effect as a “V-bounce”—when the equity market rebounds, countering the speed and shape of the end of the bear, thereby forming a V-shape market performance graph.
Figure 2 shows global equity market returns for the 2008 bear market’s final stages and the new bull market starting in March 2009—a typical V-shape rebound. For a period, the trajectory of the new bull nearly perfectly mirrored the late stage of the bear, and the global equity market had a historically massive bounce off that bottom—73% respectively from March 9 through year end![i]
Figure 2: World Equities—V-Bounce Effect 2009
Source: FactSet, as of 14/11/2018. MSCI World Total Return Index with net dividends in USD from 30/09/2008 to 31/12/2009. International currency fluctuations may result in a higher or lower investment return.
Investors who decide to sell their assets in the middle of a bear market may feel better for a time, but they may be doing themselves more harm than good. Ultimately, it’s human nature to want to feel some control over what is happening, and many investors feel that by selling during a bear market, they are in control and avoiding further losses. However, this feel-good story may not have a happy ending.
Missing out on a bull market’s beginning can cause huge missed returns—and potential profits—that normally occur off the bottom of a bear market with the V-bounce. Whereas being fully invested for the initial thrust of a bull market can help erase a big portion of bear market losses. Too often, investors who sell during a bear market miss this initial upswing and end up incurring bear market losses and missing the bull market’s following gains—effectively getting whipsawed on both ends.
There is no bull market “all clear” signal, so it's nothing you can prepare for—and the opportunity cost of missing even the first three months can be massive and lasting. When investing, endeavour to keep your long-term financial goals in mind and react accordingly. Volatility tends to be huge on both sides of the market bottom. It’s only in retrospect you know which volatility you’re suffering through—late bear or early bull. You can’t know, so don’t miss it.
[i] Source: FactSet, as of 14/11/2018. MSCI World Total Return Index with net dividends in USD from 30/09/2008 to 31/12/2009. International currency fluctuations may result in a higher or lower investment return.