With the market tumbling sharply this year, January showed a loss of 8,98% in 2022, we have to ask the question: “Are we in a bear market?” It all depends on where you look.
A bear market is defined as a drop of 20% or more from the top. Just as a bull market is defined as a rise of 20% or more off the bottom. The Russell 2000 is down more than 20%. That means we are officially in a bear market for small cap stocks. The Dow, the Nasdaq and the S&P 500 have merely trended into a correction, defined as a drop of 10% from the high. However, they may move into bear market territory in the weeks ahead.
Let us have a look at the brief history of bear markets:
– Since 1929, the S&P 500 has suffered 14 of them. We could consider the number as 15 if we include the 19.8% drop that ended on Christmas Eve 2018.
– The shortest bear market on record was the last one, in the first quarter of 2020. It lasted just 11 days before finding a bottom.
– The longest was from March 1937 to April 1942. That’s about 5 years!
– The deepest was the 86% collapse from September 1929 to June 1932.
– The average bear market lasts nearly 10 months and produces a 39% loss from the peak.
Because no one can accurately and consistently predict bear markets, investors need to prepare for them in advance. That doesn’t mean sitting in cash, earning a negative real return on your money. Or jumping in and out of the market. If you do that, you risk being in during corrections and out during the rallies. You should prepare for bear markets as following:
1. Buy only high-quality shares
2. Diversify broadly across several sectors
3. Use a sell discipline to protect your principal and your profits
4. Spread your risk outside the stock market with precious metals, commodities, bonds, crypto etc.
This won’t keep you completely unscathed in a bear market but your diversification spreads the risk and you will most-likely experience a smaller dent in your portfolio. Protect yourself from a total wipe-out (e.g. owning low quality stocks or being highly leveraged). There is no recovering or comeback from a complete wipe-out.
All of history’s greatest stock market investors, like Warren Buffett, Peter Lynch and John Templeton, didn’t just hold undervalued stocks through bear markets. No, they actually added to their portfolio when stocks were on sale.
While the average investor compares his portfolio’s current value with its highest value and kicks himself for not magically selling at the top, a smart investor uses the market fall as an opportunity.
Sven Franssen