With the recent market downturn, I’ve received a lot of questions about bear markets and how best to answer them. Here are some frequently asked questions that might be helpful.
Q: What is a bear market and how is it different from a market correction?
A: There is no “official” definition of what constitutes a bear market, but investors have traditionally argued that a bear market is a drop of more than 20% from the previous high in the market. A market correction is generally considered a 10% decline.
Using these definitions, parts of the market are currently in bearish territory. For example, the tech-heavy NASDAQ Composite Index is down more than 27% from its peak in November last year, well into bearish territory. However, at its worst so far this year, the S&P 500 was only down about 18% – technically still a “correction”.
Q: How far can a bear market go?
A: Bear markets can be devastating for unprepared investors. Since 1929, the S&P 500 stock index has suffered 13 bear markets. The worst of them, starting with the Great Crash of 1929, saw the index plummet 86% before finally hitting bottom 32 months later. In March 1935, it staged an impressive rally, rising 129% before the bear market resumed in 1937. The rally, however, was little comfort to investors. The blunt reality of bear market math is that an 86% loss requires a subsequent return of 625% to break even. It took more than 15 years from the start of the bear market in 1929 to the return of the S&P 500 to its pre-crash level.
Fortunately, not all bear markets fall this far or last this long. The COVID-induced bear market in February 2020 lasted less than a month and the market fully recovered within six months. If you exclude the bear markets of 1929 and 2020, the average bear market decline is 37.5% and the full recovery time is about five years.
Q: How do we know when a bear market is over?
A: I usually get this question from people who want to wait for the market to give the clear signal before investing. This thought process is driven by fear and usually leads to poor results over time. The only sure way to know that a bear market is over is to see it in your rear view mirror. At that time, the best opportunities will also be in your rearview mirror.
A better strategy is to assess the opportunity in the market at any given time instead of worrying about whether the market might go down. Ask yourself if the market is currently priced to produce a reasonable return over the long term. If so, invest. Remember that you don’t have to invest everything at once. For most people, it’s best to buy in bear markets a little at a time over an extended period of time.
Q: What is the best way to deal with a bear market?
A: The key to successfully navigating a bear market is to focus on portfolio resilience. A resilient portfolio has three characteristics. First, it is invested in high quality assets. Second, it is well diversified. Third, it is structured to be able to meet expected drawdowns without having to sell shares at unreasonable prices. If your portfolio has these three characteristics, you can face difficult markets without fear or frustration.
Q: Is it too late to fundraise?
A: This seems to be a favorite question right now. Those who ask are usually trying to decide if the damage is done or if there is room for further declines. They want cash so they can buy stocks if the market gets really cheap. It’s impossible to give a single answer to this question, so I usually say it depends. Do they have the resources to meet their spending needs? Do they hold significant cash elsewhere? How does this portfolio compare to their overall wealth position? How will the increased risk of being out of the market affect the viability of their long-term goals? If you’re wondering if you should raise funds in your portfolio, I encourage you to explore these questions with your advisor.
Steven C. Merrell is a partner at Monterey Private Wealth Inc., an independent wealth management firm in Monterey. He welcomes your questions regarding investments, taxes, retirement or estate planning. Send questions to Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to [email protected]