“In bear markets, stocks are returned to their rightful owners”
-J.P. Morgan
In last month’s article, we shared a favorite parable about the value of maintaining equanimity in the face of changing conditions. This month, we discuss how great investors always see opportunities when others are in crisis.
The Bear Flashes His Teeth
If you type the words “Bear Market” into the search engine on Investopedia, you will learn that a bear market is defined as a time when:
A market experiences prolonged price declines amid widespread pessimism and negative investor sentiment. Bear markets also may accompany general economic downturns such as a recession.
The investing world has adopted a somewhat arbitrary definition for knowing if a bear market, a condition when equity prices fall 20% or more from recent highs, is occurring. Although this 20% “line in the sand” is not particularly meaningful, it does provide the financial media with an official signal for when they can begin to produce all kinds of fearful headlines about how the US equity market has “plunged” into bear territory. Any time the equity market breaks this 20% barrier, you can count on hearing all about it on the business news that evening.
On June 14, 2022, the S&P 500 officially broke through this barrier and entered bear market territory. After reaching an all-time high of 4,796 on January 3, 2022, the S&P 500 closed at 3,749 on June 14th, for a total decline of almost 22%.
Another reliable feature of every bear market is that they are almost always accompanied by a certain degree of existential fear. They are scary not just because equity prices are falling, but because they almost always occur during a time when the world is convinced that some geopolitical or economic catastrophe is sure to tear down the fabric of our lives and the economy as we know it.
This catastrophe always seems to be both novel and insoluble. We convince ourselves that the problems we’re facing today are unlike any other situation that the world and our economies have met before, so we are not equipped to solve them. We begin to believe that even though mankind has solved every problem we faced in the past and still flourished, it is this particular problem that will bring us down. In short, we begin to utter the four most dangerous words in investing:
This time is different.
In the mid-1970s, runaway inflation and gas shortages were going to be the killer death blow that would bring down the American economy. Then in 1987, a single-day meltdown of stock prices threatened to plunge the world into another Great Depression. In the year 2000, the tech bubble meltdown and related corporate malfeasance were indications that the American economy was a fraud and could not possibly survive. In 2008, the entire global credit system was just inches from total collapse. Then in 2020, the world was gripped by a pandemic that forced the global economy onto life support.
And so today, we again face runaway inflation and the prospect that the Federal Reserve will need to raise interest rates and choke off the American economy to arrest price inflation. Predictably, at moments like this—although it is useless to make predictions about what will happen next—we will hear dire predictions from gurus, experts, and investing legends who dominate financial media airwaves. J.P. Morgan CEO, Jamie Diamond, gave an ominous interview on CNBC last week in which he argued that “a hurricane is coming” for the US economy. With all due respect to Mr. Diamond, that’s what they always say when a bear market strikes. This is the language of panic, and it’s how you know you are in a bear market.
Perspective During Chaos
We have found that successful investing is quite tricky for those focused on the immediate “news of the day” and base their investing decisions on the vicissitudes of the momentary conditions in the economy and the markets. Short-term conditions are unpredictable and volatile, and our focus on the news of the moment tends to trigger emotional volatility, even for the most seasoned investor.
For that reason, we here at Concentus always hesitate to make short-term predictions or prognostications—we have found this to be the easiest way to make a mistake. However, we do believe that our favorite economist, Brian Wesbury, offers some valuable perspectives in this article. For the reasons he outlines, we have a hunch that market participants are over-reacting to the probability of a recession occurring soon.
More importantly, the hallmark of all long-term, goal-focused investment policies is the practice of rationality during periods of uncertainty and volatility, especially when the entire world around us is experiencing panic. The only way to think rationally about the current crisis is to draw from our experience of how other scary events in the past unfolded so that we might understand the long-term implications of this one.
As we have suggested many times in this space, investing in life’s most important goals always requires a long-term perspective. When we consider that the average American will spend 30 years or more in retirement and that most of our valued clients hope to leave behind their wealth to future generations after they have left this world, it becomes clear that the short-term vicissitudes of markets are much less important than the long-term realities. Indeed, for many of the readers of this commentary, your investment decisions today are likely to impact your grandkids many years from now.
With that in mind, we here at Concentus have always found our “Bear Market Chart” to be an extremely useful tool for gaining some perspective when markets go haywire. As we are experiencing a bear market today, it may be helpful to look at how bear markets of the past have behaved. As you view this chart, please keep in mind:
- We included three episodes during which the S&P 500 declined slightly less than 20%, simply because they felt like bear markets, too.
- This chart does not include dividends in the S&P 500 return, making these bear markets appear worse than they were. As a result, this chart brings the investor closer to the actual emotions experienced in real-time when the bear strikes.
- It is worth noting that the dividends paid on the S&P 500 are roughly 65 times higher today than they were a century ago.
- We have indicated the current bear market SO FAR by highlighting in yellow the current level of the S&P 500 as of June 17th. Of course, this particular bear market may be over now and begin to recover, or it may have further to go. There are no facts about the future.
The takeaways from this chart are:
- As we suggest annually in our January commentary, we should be prepared that a bear market can spring up at any time, and we should never be surprised when one arises. Bear markets happen all the time, about once every five years on average. They are a natural part of the long-term investment cycle.
- Historically, bear markets can cause temporary declines of 20% to 50% of equity capital.
- However, during this period of 76 years, the stock market moved from 19.3 in May of 1946 to 3,674 today. In just about the length of a human life span, the patient investor returned over 190 times her money, not counting the significant impact of dividends, over this period.
Bear markets happen, and they can be painful. Historically, however, they have always been temporary setbacks in a long-term uptrend; the declines are quick, and the advances are permanent.
Empowered vs. Victimized
Before we leave the topic of volatility, it is also important to point out a transformative insight that can be drawn from truly understanding this data and allowing the investor to use market declines as opportunities to remain confident while everyone else around us is screaming in terror and uncertainty.
When we understand and come to peace with this data, we can begin to embrace equity volatility as a positive phenomenon and the reason for the premium return from equities. The term “volatility” refers to the equity market’s relatively large and unpredictable movements, both above and below its permanent uptrend line. Equities can, and frequently are, up over 20% one year and down 20% the next, and vice versa. However, suppose we believe that the long-run returns of equities will approximate the past return. In that case, we begin to understand that these periods of downside volatility must likewise, at some point, be corrected by a period of upside volatility greater than the long-term average of roughly 10% per year.
The premium returns of equities are, therefore, the efficient market’s way of pricing in adequate compensation for tolerating such unpredictability. Volatility is the reason equity investors are rewarded over time with premium returns if they have the emotional strength to live through it. For the wise and patient investor, it also provides a unique opportunity to accumulate more equities during a time when prices are temporarily depressed … kind of like a “Big Sale.”
Put another way, we invite you to study the chart above, paying particular attention to the sequence of market “tops” which preceded each past bear market, depicted in the 2nd column from the left on the chart. And then ponder the following questions:
Imagine that you were somehow granted the use of a time machine and could go back in time to any of the dates shown on the chart, during which the S&P experienced a “top,” just before a vicious bear market. Knowing where the S&P 500 is trading today, would you go back in time to any of these dates and invest your hard-earned capital at that “top?” Would you further seize the opportunity to invest in any of the “bottoms” shown on the chart?
Every one of these bear markets rattled investor emotions. In every instance, people were tempted to believe that “this time is different,” new, and unsolvable. In the fullness of time, each scary episode listed above can be regarded as an exceptional buying opportunity for patient, long-term investors.
Far from an opportunity to sell or reduce your equity exposure, at Concentus, we regard the recent volatility as a buying opportunity. While equity prices may very well be lower in a month, six months, or in a year, we are confident that investors with a reasonable time horizon of 5 years or longer can feel very comfortable using this current volatility as an excellent opportunity to buy equities while they are on sale.
For our clients and friends who are already fully invested in equities, we advise that you stay that way. For those who are funding periodic savings plans such as a 401k plan, we suggest you temporarily accelerate your pace of investment if you can afford to. And for those lucky enough to be sitting on a more meaningful stash of cash or bonds … opportunity is knocking.
As always, we welcome your inquiries about this issue. In the meantime, we think the most helpful–and certainly most heartfelt–investment advice we can offer would be that you turn off the television set.