BUNK 8

ONE BIG BEAR AND YOU’RE DONE

Bear markets hurt emotionally—a lot. I call the stock market The Great Humiliator (TGH). And TGH likes nothing more than scaring as many people out of as many dollars for as long as it can—before it goes up (or down). A bear market is TGH at its absolute deadliest.

TGH robs people of returns any way it can. First, near term, you’re down big. Huge unrealized losses. Utter humiliation, fear, and agony. Also, TGH knows people hate losses more than they love gains. Therefore, bear markets are so painful they make folks do crazy things that ultimately hurt them—for most of them, much worse in the long term than if they simply sat on their hands. Things like capitulation-selling at the absolute low. Far too many investors, on their own, do this to their heavy detriment—often in the name of “waiting for clarity.” Or, in the depths of bear market agony, many investors suddenly decide they can’t handle big stock volatility anymore (or whatever the myriad other reasons) and change their long-term strategy to hold a bunch of cash and bonds, right in time to miss the huge stock market bounce off the bottom. (Read more in Bunk 9.) And maybe a bunch of those investors even swear off stocks for years, then change their minds again late in the next bull market (missing most of the upside), thinking they’ve gained a new sense of “clarity” that will evaporate (again) in the subsequent bear—which whacks them (again). TGH is cruelly perverse.

Another variation: Some say they’ll stay with stocks until they “get back to even” or hit some other arbitrary milestone, and then they’ll change their strategy—hold cash and bonds because “bonds are safer.” (Maybe not—remember Bunk 1.) But if they think stocks are the right asset class to get the growth they need to return to their portfolio high-water mark (or some other arbitrary level) in the near term, then why don’t they think stocks can get superior growth longer term? This, too, is perverse. Near term, myopic goals imply a short investment time horizon, for which stocks are almost never appropriate. Longer-term goals imply a longer time horizon, for which stocks are—more often than not—most appropriate. Many investors have trouble thinking this through.

Big Bear Markets Mean a Big Bull Bounce

Facts are: If you have a long time horizon (if you’re reading this book, you likely do—see Bunk 3) and goals requiring equity-like growth, a bear market doesn’t change that at all—or much of anything relative to what you should do moving forward. What folks fear is being in a hole they can’t get out of. They know if stocks drop 25 percent, it doesn’t take a 25 percent up-move to breakeven—it takes 33 percent. It takes nearly 43 percent to recover from a 30 percent drop. And if stocks fall huge, as they did from October 2007 to March 2009 (down 58 percent¹), it takes a 138 percent move just to get to breakeven, not to mention getting any real growth from there. And after all the problems newly envisioned and emerged during the bear market, they have a nearly impossible time fathoming stocks rallying that much—TGH at work again. It never changes.

Is it scary? Sure. Impossible? Nah—something we’ve seen endlessly through history. Bear markets are normal—happen periodically. Sometimes they’re bigger than others. But through history, stocks fall—even huge—then recover and hit new highs again and keep going. If bear markets were unrecoverable, stocks would only fall—but they don’t. They rise more than fall, and eventually (and irregularly) keep marching higher over time. And almost always, the bigger the bear market decline, the bigger the subsequent bull market. That isn’t always true, but usually is. And even when it isn’t, you’re better off with whatever subsequent bull market returns you get than if you bailed at the bottom and stagnated in cash—always.

Maybe you think, “It’s different this time”—Sir John Templeton’s famous “four most dangerous words” in investing. It’s almost never different this time in any basic way. Yes, details differ, but the fundamentals driving stocks don’t. And human behavior is pretty darn predictable in the way we react to bear market fright. So over long periods, stocks should keep rising overall, with intermittent downside volatility, big and small.

Remember: The future includes as-of-yet unimagined earnings from currently unfathomed products and services born of the boundlessness of human ingenuity, innovation, and desires in years to come. Always been that way. Forever, people have been moaning about stocks being too high and Capitalism done. Fine—but every single time they’ve been proven wrong. If you’re betting with long-term capital, I suggest you bet on the side of it not being much, if any, different this time—despite it always feeling different (and the media always giving you countless reasons for why it is now and will be different).

Often the popular conclusion is that social and political trends will overwhelm Capitalism. That isn’t a new view. Yet—not always, but almost always in democratic nations globally—Capitalism has ended up more powerful than politicians, social trends, and temporary political will—and wins out in the end. (A concept Steve Forbes depicted very well in his terrific 2009 book, How Capitalism Will Save Us, published by Crown Business, 2009.)

Fooled by Averages

One reason many fear bear markets are insurmountable is they’re fooled by averages. (A similar problem for those who believe they should “sell in May”—see Bunk 25.) Long term, stocks have averaged about 10 percent per year—give or take a bit (depending on what time period you measure and how you measure it). So if you need 33 percent, 45 percent, or 140 percent to get back to even, that seems like it would take a really, really long time. Except—and people can’t seem to get this—the stock market’s long-term average includes bear markets. Let me say that again—stocks have been down huge during past bear markets, yet still they averaged about 10 percent a year. Why? Normal stock returns aren’t average—they’re extreme, both up and down, normally! (See Bunk 5.) Folks can somehow accept that stocks can be down a lot—so why can’t they remember they’re often up a lot too?

This is basic debunkery—looking beneath the averages to what comprises them. Always do that. Bull markets are longer and stronger than people think. Another way to say that: Bull market returns are inherently above average. Have to be—to make up for the big down years. Table 8.1 shows returns for all bull markets since 1926. On average, bull market returns annualize 21 percent! And though duration varies wildly, they last much longer than many think.

Table 8.1 Bull Market Returns—Inherently Above Average

Source: Global Financial Data, Inc., S&P 500 price return.

Plus, the bigger a bear market, the bigger and swifter the returns can be—and usually are—off the bottom. (See Bunk 9.) People think, “Well, I went through that big bear market and am down big. Now I must hold mostly cash and bonds to protect myself from future potential risk.” Wrong—looking backward tells you nothing about what happens next. Investors should look forward, always, and consider what their long-term goals are, free from TGH’s bear market freak-out fears. Don’t be fooled by averages. Bear markets can be big, but bull markets are longer and stronger and likely will be as prevalent in our future as in our past.