Bear market counseling

Whilst thinking about and researching my year-end newsletter, I came across a piece that I wrote for my clients back in July 2017. The gist of it was that a bear market (officially defined as a 20% or more fall in the stock market) can happen at any time. We always know that one is coming, we just never know when it will come. The key is that we must never panic when it happens. People panic because they are surprised. If I can take the surprise element out by continually helping people understand what it will feel like when it happens, then we are much less likely to end up making emotional decisions in the moment.

Fast forward 18 months and we find ourselves in the middle of a correction, and near enough a bear market (the S&P 500 fell 19.8% between September 20th and December 24th).

My words of counsel back in July 2017 are a very useful reminder of how markets work, and how we long-term investors are rewarded.

Here follows my newsletter from July 2017:

If you have been to any of my talks you will have heard my ‘bear market counseling’, a.k.a. your ‘lifeboat drill’.

It goes like this.  The wonderful thing about investing in companies (equities) is that the return is (over the long-term) so much higher than from other asset classes.  The not-so-wonderful thing about investing in companies is that in order to earn the return we have to withstand the temporary falls.  The temporary falls can be painful, so painful that people often give up, conclude they cannot take any more pain and sell.  One will always live to regret that decision.

So let’s not make that mistake.  If only it was as easy as that.  Simple. Done.

It’s not of course.  And that’s because, in the middle of a big market fall (bear market) our intellect takes the back seat and our emotions take the driving seat.  And our emotions are our biggest enemy. 

However, I believe that with a lifeboat drill or two (in advance of hitting the iceberg), we can limit the coming damage.  And maybe we can do even better than that by turning it into an advantage.  A big part of the reason why people panic is that they are surprised.  The analogy is to imagine your cruise ship captain telling his passengers hours before hitting the iceberg that a collision is coming.  But he announces it, calmly telling the passengers that there are enough lifeboats for everyone, that they are to line up on the deck and that he will have each and everyone of the passengers in lifeboats hours before the boat goes down.  The scene on deck is likely to be relative calm, and certainly nothing like the pandemonium we saw Kate and Leo face in the movie when surprise and panic struck together.

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That’s what I need to do with the bear market.  I know there will be another bear market.  And I don’t want you to be surprised by it.  Because surprise is what leads to panic.

The only problem is that although I know it will come, I don’t know when.  Nor do I know what will cause it, how bad it will be or how long it will last.  But I do know that the only way to survive it is to ride it out.  Of course that’s not the sensible advice we hear or see in the media.  Instead we are bombarded with the words ‘recession’, ‘correction’, ‘bear market’ with no real explanation and certainly no historical context. 

So, how can I help you through it when it comes?  Going back to basics and really understanding what these terms mean, historically, is a great starting point.  Those of you who are my regular readers know that in the absence of that elusive crystal ball, I tend to resort to looking at history.  Because as Winston Churchill said ‘the farther back you can look, the farther forward you are likely to see’.

 These are the five things we need to know, and remember*.

1)     All the stock market ‘corrections’ in my lifetime, your lifetime and long before, have all been temporary.   That is, each one has ended with the resumption of the long-term uptrend. 

2)     Since the end of the second-world war there have been 57** stock market ‘corrections’ in the S&P 500 (the US stock market), which are officially defined as declines of ten percent or more.  That is a 71 year period, so it makes an average of about one every fifteen months.

3)     During that same 71 years there have been eleven recessions, which are officially defined as a decline in US GDP lasting for at least two calendar quarters.  That makes an average of about one recession every six and a half years.  The economy was in recession, on average, for 11 months.  The 71 year period is 852 months.  11 recessions lasting an average of 11 months each means the economy was in recession for 121 months, or around 14% of the period.  Let’s think positively though (I always do) and spin it around; the other 86% of the time, the economy was growing!

4)     During the same 71 years, there have been 14*** bear markets defined as a decline in the stock market of 20% of more.  That’s an average of one every five years.  (Note, three declines were 19% but I am including them in the count above, because although they may not quite have been officially a bear market, they sure felt like a bear market).

5)     During this 71 years, when stock markets were correcting 57 times and going through 14 bear markets, the S&P 500 went from 15 to 2,240****.  That’s an increase of about 150 times.  The dividend, if you have retired and are therefore interested in income, went from 71 cents to $45, up about 65 times.

There are a few ways you could interpret this data, but to me, this is the most rational and relevant interpretation:

A long-term equity investor, who had a plan and stayed focused on the long-term trends probably did pretty well and most likely succeeded in, not only generating a growing income in retirement, but also leaving a significant legacy.  The investor who was prone to panic and did so on even just one of the occasions that the market entered one of its temporary corrections, probably did a whole lot less well.

Remember, it’s ok to feel the fear when the market falls (we all feel it), it’s just not ok to act on the fear.  We all have a choice of what we focus on in life, and in particular with our money.  Focusing on short-term market movements and arbitrary benchmarks leads us down a dangerous path, because not only can we not predict, time or control them, the reality is that they don’t even matter.  Our long-term goals and plan are what matter, and that’s where we must choose to focus.

* data from Nick Murray

** now 59 (we had two in 2018)

*** now 15 (if we include the 19.8% fall in 2018)

**** now 2506

If you are questioning the advice you are being given, or are concerned about how your portfolio is positioned, or want to take advantage of the fact that stocks are considerably cheaper today than they were a year ago, drop me a line....I always offer a coffee and a second opinion.