For investors, the stock market can be both a wondrous and a stressful thing. During bull markets (when markets are generally rising over a span of multiple years), investing can feel rewarding as your account value may rise with stocks in general. On the other hand, bear markets (fundamentally driven stock market drops of 20% or more over an extended period) can be terrifying.
Scary events can lead to ghost stories. In this case, that means many investors have a tough time shaking some myths about bear markets. And if you believe some of these myths and take action in your portfolio based on them, it could be costly. In this article, we'll address some common bear market myths and the realities that contradict them.
When the market drops suddenly and sharply, cries of “bear market!” are usually soon to follow. This isn’t totally illogical— sharp declines and bear markets often go together. However, bears almost never start this way.
This myth leads many investors to believe you must be quick to identify a bear market and get out of stocks. However, bears are often slow moving at first, so we believe it is often best to wait until after you think a bull has already peaked before going defensive. Bull markets often end when they reach the top of the proverbial "Wall of Worry." When markets reach the end of this wall, investors become euphoric and bid stocks up regardless of deteriorating underlying fundamentals. The bull market then rolls over slowly and investors may see the new bear as a buying opportunity for stocks rather than the onset of a downturn.
Bears commonly start via the Wall, when folks are investing in companies based on sky-high expectations and hype. However, within bull markets, there can be plenty of shorter downturns amidst the bull’s climb. Bull markets often incur multiple market corrections (sentiment-driven stock market drops of roughly 10% to 20%) throughout their climb. These corrections are a normal, healthy part of a bull, and jumping out of the market at every sign of turbulence in a bull can be extremely costly. Instead of reacting to sharp drops, we believe it is more helpful to watch out for a slower, rolling top amidst euphoric investor sentiment.
Though linked, the stock market and the economy are not the same. The economy refers to the production and consumption of goods and services over a defined time period, whereas we refer to the stock market as an ongoing reflection of investor expectations of future corporate profits.
Some investors mistake bear markets for economic recessions—typically defined as declines in gross domestic product (GDP) for two or more consecutive quarters. Though the two sometimes overlap, a falling or volatile stock market doesn’t necessarily mean an economic recession is in progress. Stocks are forward looking—they tend to move ahead of the economy. For instance, the bull market of the aughts (00s) peaked in October 2007, but a recession didn’t start until the very end of the year.[i] Similarly, while stocks started a new bull market in March 2009, the economy didn’t enter expansion until June. And history has seen many bear markets that were accompanied by perfectly healthy economies. Bears and recessions simply don’t always go hand in hand.
This means if you use GDP releases to try to predict a bear market, you’re likely too late. Stocks have likely already digested changes in economic activity and reflected those changes in their forward-looking prices.
Bears can be taxing on investors. When you invest, you may feel the pain from losses more than you feel the benefit of gains. In behavioral finance, this phenomenon is called myopic loss aversion. It can make bears seem like irreparable and crippling events, but in reality, many investors can handle bears so long as their emotions don’t get the best of them.
This fear of losses often causes investors to make emotional, irrational decisions that can hurt them much more than enduring a bear market might. For example, if the stocks you invest are down a lot during a bear, you could end up selling stocks to save what you have. However, you could be selling near the bear’s low—a costly mistake.
If you have a long investment time horizon (how long you need your portfolio to last) and goals requiring equity-like growth, a bear market doesn’t change what you should do moving forward. What investors fear is being in a hole of which they can’t get escape. Throughout history, stocks have fallen—even huge—then recovered and hit new highs again and kept going. If bear markets were unrecoverable, stocks would only fall—but they don’t.
Though panic during bear markets can make you want to flee from stocks, the risk of bailing out of stocks and missing the initial rebound can be even more crippling than the bear market itself. It’s tough, but remember to think long-term. Over the long-term stocks generally rise, even after bear market losses.
If you have trouble weathering market volatility or downturns, you may benefit from working with a trusted adviser. Fisher Investments has educated many investors about bear markets and behavioral investing, and we may be able to help. Call us today or download one of our educational investing guides to learn more.
[i] Source: Global Financial Data, as of 11/12/2018. S&P 500 Price Index Level from 01/01/1960 – 11/05/2018. Economic recessions as published by the National Bureau of Economic Research.