Behavioral Finance

An Uncomfortable—but Practical—Refresher on the Agony of Bear Markets

Ponder the bear while the bulls are still running.

US stocks are a hair from all-time highs and over a decade has passed since the last global bear market. Yet amid the bounty, investors are glum. August’s volatility sent bearish sentiment spiking in the US.[i] European confidence tanked. One survey showed German investor expectations hit all-time lows in July—only to tick lower in August.[ii] Fund outflows accelerated worldwide, continuing even after stocks resumed climbing.[iii]

That a brief -5.9%[iv] slide in global stocks sparked such angst hints at the vast torment a bear market—a prolonged, fundamentally driven decline of -20% or more—might bring. It highlights a key point: Recalling some general bear market traits now can shed light on the mindset you’ll need to navigate future bears, regardless of portfolio positioning.

I know, thinking about bear markets is no fun. Who wants to relive 2008 – 2009’s terror or 2000 – 2002’s bursting Tech Bubble? But as they wear on, bear markets distort reality. They make even rational people believe in outcomes that might seem far-fetched today. So the time to think about what you’ll face in bear markets is during bull markets—like now, in my view. Regardless of whether you (or your financial professional) identify the next downturn early and mitigate the declines, thinking about what to expect from a bear ahead of time, while markets are comparatively calm, can be a big benefit later.

1. Don’t expect the bear to announce its arrival.

Bears typically don’t start with a bang. They roll over gradually, with stocks sliding down a proverbial slope of hope. Most remember the harrowing swings of late 2008, but many forget stocks started edging lower almost a year earlier. Six months into the 2000 – 2002 bear, the S&P 500 was only about -5% below a record high.[v]

Early in a bear, investors usually aren’t panicked—they brush aside real risks and expect stocks to do the same. The major pain comes later—usually, the final third of bear markets’ lifespans contain about two-thirds of their total decline. If everyone is worried a bear just started, you probably aren’t in a bear. If everyone is shrugging off negative news, your ears should perk up.

2. Expect at least one major news outlet to proclaim the “Death of Equities” or a related paradigm shift.

Sir John Templeton famously said the most dangerous words in investing are “this time it’s different.” The phrase usually surfaces in bear markets and their aftermaths (when people doubt the rebound’s legitimacy). BusinessWeek’s 1979 cover story heralding “The Death of Equities”[vi] is the most famous “this-time-it’s-different” example. Ironically, it ran during a bull market, but the concept is the same: The theory extrapolated existing negatives—in that case, crushing inflation—out indefinitely. Folks do the same with bears, presuming negativity will continue forever. BusinessWeek’s call showed the folly in that—over the following four decades, the S&P 500 rose 8,297%.[vii]

While BusinessWeek’s cover is legendary, other examples of this thinking abound. In September 1974, The New York Times pondered “Why This Bear Market Is Different.”[viii] (It wasn’t.)  Newsweek asked, “Is There No Bottom?”[ix] (There was.) In November 1987, Time’s cover proclaimed, “After a wild week on Wall Street, the world is different.”[x] Headlines from the 2007 ­– 2009 bear and its aftermath included “R.I.P. Equities 1982 – 2008: The Equity Culture Loses Its Bloom”[xi] and “10 Reasons The ‘Death of Equities’ Is Real This Time.”[xii] And don’t forget those blaring warnings about a “New Normal” of low returns on stocks.[xiii] Reality turned out to be a lot like the Old Normal, in my view.

Of course, in all these cases the particulars were different. But the fundamental forces that shaped economies and markets—supply and demand, fear and greed—didn’t change. When prices plunge late in bear markets, however, most investors mistake cyclical events for permanent game-changers. The justifications are often the same: technological changes, demographic shifts, globalization, regulation, deregulation, partisan acrimony. They have been around for decades—don’t let them fool you.

3. Expect to hear a lot from a small group of pundits who “called” the bear.

These pundits will get ample ink and pixels. In most cases, their outlooks will remain dour. But don’t let their headlines overwhelm you. Dissect them. Ask questions. Remember that often those who end up getting credit for “calling” bear markets have called seven of the last two bears. Or they called the bear years early—unhelpful to someone needing equity-like long-term growth. Finally, when do they propose getting back in? In my experience, many do so far too late to really take advantage of their “sell” calls.

4. Don’t expect the next bear to be “easy.”

Given the last two bears have been historically bad, the next one could be more typical, i.e., less severe. But “more typical” doesn’t mean “easy.” Bear markets, almost by definition, turn terrifying in their late stages. If they didn’t, you wouldn’t get hordes of investors panic-selling near a market low—which means you wouldn’t get the major declines that define a bear market.

If you stay invested through a bear, you could be terrified the declines won’t stop. Even if you reduce equity exposure and successfully dodge a portion of the downside, you could easily be petrified of getting back in. That risks squandering the benefit of your earlier move—sidestepping downside only benefits you if you get back in at lower levels.

Fear is worst when unexpected. Anticipate that any bear will be scary—increasingly so as markets decline further—and you take away some of its power.

5. Do expect to want to throw everything you know out the window.

You can read your market history, post John Templeton quotes over your bed and think you know just what a bear will bring. For a while, you might be right. But as the declines snowball, something you haven’t foreseen will make you think, “Well this makes everything I know about bear markets irrelevant!” That is the bear messing with your brain. 

This isn’t to say you can’t adjust to changing situations. But don’t alter your course because you fear economies’ and markets’ underlying natures no longer apply.    

Bear markets are no fun to talk about. But mentally preparing now can help you keep your cool when others are losing theirs. The less surprised you are by the bear’s tricks, the likelier you are to avoid the panic that turns investors into their own worst enemies.



[i] American Association of Individual Investors, Sentiment Survey, as of 9/18/2019. https://www.aaii.com/sentimentsurvey/sent_results

[ii] Source: FactSet, as of 9/24/2019. ZEW balance of investors expecting the DAX stock market index to rise minus fall. Data begin in December 1991.

[iii] Source: Investment Company Institute, as of 9/19/2019. Combined Estimated Long-Term Fund Flows and ETF Net Issuance. http://www.ici.org/info/combined_flows_data_2019.xls

[iv] Source: FactSet, as of 9/26/2019. MSCI World Index, net return, 7/24/2019 – 8/15/2019.

[v] Source: Yahoo! Finance, as of 9/26/2019. S&P 500 returns, adjusted for dividends and splits, 3/24/2000 – 9/1/2000.

[vi] “The Death of Equities,” BusinessWeek, 8/13/1979. https://ritholtz.com/1979/08/the-death-of-equities/

[vii] Source: Global Financial Data, Inc., as of 8/15/2019. S&P 500 total return, 7/31/1979 – 7/31/2019. Data are monthly as daily total return data do not exist until 1988.

[viii] “Why This Bear Market Is Different,” Vartanig G. Vartan, The New York Times, 9/1/1974. https://www.nytimes.com/1974/09/01/archives/why-this-bear-market-is-different-different-bear-market.html?searchResultPosition=1

[ix] “Is There No Bottom?” Newsweek, 9/2/1974. Referenced here: https://www.kiplinger.com/article/investing/T031-C000-S001-diary-of-a-bear-market.html

[x] Time, 11/2/1987. http://content.time.com/time/magazine/0,9263,7601871102,00.html

[xi] “R.I.P. Equities 1982–2008: The Equity Culture Loses Its Bloom,” Julie Segal, Institutional Investor, January 2010. Note: This is the title of the original article, as per James O’Shaughnessy’s What Works on Wall Street, Fourth Ed. (McGraw-Hill Education, 2011). The online version has since given stocks a second life, dropping the “R.I.P. Equities 1982–2008,” as well as a line O’Shaughnessy quotes in his examination of this-time-it’s-different thinking: “[Investors are] systematically pulling back from equities, and Wall Street will never be the same.”

[xii] “10 Reasons The ‘Death Of Equities’ Is Real This Time,” Joe Weisenthal, Business Insider, Sept. 14, 2010. https://www.businessinsider.com/the-death-of-equities-2010-9

[xiii] “Gross Predicts a New Normal,” Arijit Dutta, Morningstar, May 28, 2009. https://www.morningstar.com/articles/293344/gross-predicts-a-new-normal

 


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