Today, Resolve Trumps Timing

Story Highlights:

• The past ten months, painful for stock investors, can't be erased. But what's important is what to do from here.
• We're probably most of the way through this bear. When it bottoms, expect a big bounce. If you're still in stocks, don't go anywhere!

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Many investors today feel like abandoning stocks. But successful investing requires assessing tomorrow's costs and benefits to inform today's decisions, not basing judgment on what's just passed.

So what should you do here and now, after markets have gone down so much? First let go of the belief that what's just happened has any predictive bearing on what will happen. Each new day requires a fresh study of what's most likely to occur next.

We suggest answering two very basic questions: Will markets go down a lot more and stay there? Does the cost of losing more outweigh the benefit of a quick rebound?

First, we don't think markets will fall much more, if at all. The last 10 S&P 500 bear markets have lost an average 32% over 16 months, or 27% over 10 months if you exclude the three most massive bears (1946-49, 1973-74, and 2000-02). A handful lost almost exactly as much as this one has already. The deepest bear markets typically coincide with big global recessions. Right now folks seem to be mistaking sluggish growth for contraction. With global markets down 25% and the S&P 500 down 20% over 10 and 11 months respectively, we don't know when exactly the bottom will come, but in our view it's likely we've already passed through most of the bear in both magnitude and duration.

What if stocks go down a bit more? When they hit bottom, they'll likely bounce. Big. New S&P 500 bull markets have gained an average 36% in the first 12 months following the bottom of the prior bear. If investors give in now, they risk missing out. Just participating in the first bit of the bull can be enough to recoup all the bear's losses. And ensuing bull markets typically earn investors an average 149% over 57 months—dwarfing even the really big, bad bears.

Though there are undoubtedly poor fundamentals in some pockets of the economy, what's more important is whether investors have correctly valued them. Currently, people are favoring what's wrong with the world over what's right—possibly because so much of the trouble is centered in the little-understood (and thus largely feared) Financials sector. But that sentiment imbalance won't last forever, and when it reverses, expect markets to respond in kind, and quickly.

When will the rebound happen? Impossible to say, but there's plenty of evidence today's bear is getting long in the tooth. The greatest stock investing mistake of all is to sell at the bottom. Surmising the exact bottom is less important than participating fully in the upside afterward. If you're still in stocks, don't go anywhere! Now is when resolve trumps timing.

* Sources: Thomson Datastream, Global Financial Data, Bloomberg; global market returns measured by the MSCI World; as of 9/11/2008