“The 2% Rule says: US bear markets, top to bottom, decline irregularly but at an average rate of about 2% per month. If a decline exceeds that, you can soon count on a pullback and a better chance to get out.”
–Ken Fisher, Forbes, “Stay Cool,” 9/21/1998
Understanding bear markets is an important factor to consider when investing in the stock market. But many investors don’t fully understand what bear markets are or how to recognize them, which can lead to emotionally driven trading decisions that can jeopardize investors meeting their long-term financial goals. We believe close monitoring of fundamental market factors is essential to identifying an approaching bear market – such as political, economic and sentiment market drivers. In our view, technical indicators alone are not sufficient to identify an impending bear market. However, our research shows bear markets rarely begin with a “bang”—they typically begin with a “whimper”: A rolling top over a longer period that lulls investors into a false sense of security.
Four rules can help identify this characteristic rolling top:
Exhibits 1, 2 and 3 show the characteristic rolling top of the S&P 500’s decline during the 1973-1974 bear market.
Source: FactSet, as of 8/14/2014. S&P 500 Price Level, indexed to 100 at 1/11/1973, from 12/31/1973 – 3/31/1975.
It’s also critical not to call a bear market falsely. If the market is just going through a correction (a short, sentiment-driven downturn of -10% to -20%), we believe you’re better off riding through it and maintaining your portfolio. It is impossible to accurately and consistently time market corrections because of the way they behave. A correction can start for any reason or no reason. Corrections lack the causes and features of the Wall and the Wallop. Here are some potential signs you’re just witnessing a correction:
Choosing to undertake a bear market investment strategy and go defensive should be rare and shouldn’t be done by gut feel or by your neighbor’s opinion. Exiting the market is among the biggest investment risks you can take—if you’re wrong and you have a need for portfolio growth, missing bull market returns can be extremely costly. Importantly, there are no hard and fast market rules for an investor to blindly follow. Rather, staying informed about current market drivers and understanding the causes and indicators of bear markets are important parts of maintaining a disciplined portfolio management process aimed at achieving your longer-term investment goals.