With the recent downturn in the markets, I have been getting a lot of questions about bear markets and how to best respond to 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 held that a bear market is a decline of more than 20 percent from the previous market high. A market correction is generally thought of as a 10 percent drop.
Using these definitions, some parts of the market are currently in bear market territory. For example, the technology-heavy NASDAQ Composite index is down more than 27 percent from its high in November of last year—well into bear market territory. However, at its worst so far this year, the S&P 500 index was only down about 18 percent—technically still a “correction.”
Q: How bad can a bear market get?
A: Bear markets can be devastating to investors who are unprepared. Since 1929, the S&P 500 stock market index has suffered through 13 bear markets. The worst of these, starting with the Great Crash of 1929, saw the index plummet 86 percent before it finally hit bottom 32 months later. In March 1935 it staged an impressive rally, rising 129 percent before the bear market resumed in 1937. The rally was cold comfort for investors, however. The brutal reality of bear market math is that a loss of 86 percent requires a subsequent return of 625% to get back to breakeven. It took over 15 years from the time the bear market started in 1929 until the S&P 500 finally recovered to its pre-crash level.
Fortunately, not all bear markets drop that far or last that long. The COVID-induced bear market in February 2020 lasted less than a month and the market fully recovered within 6 months. If you exclude the 1929 and 2020 bear markets, the average bear market decline is 37.5 percent and the time to full recovery is about 5 years.
Q: How can we know when a bear market is over?
A: I usually get this question from people who want to wait until the market gives the all-clear signal before they invest. This thought process is driven by fear and generally leads to poor results over time. The only sure way to know that a bear market is over is when you see it in your rearview mirror. By that time, the best opportunities will also be in your rearview mirror.
A better strategy is to evaluate the opportunity in the market at any particular point in time instead of fretting over whether the market could go lower. Ask yourself if the market is currently priced to produce a reasonable long-term return. If it is, invest. Remember, you do not have to invest everything all at once. For most people, it is better to buy into bear markets a little bit at a time over an extended period of time.
Q: What is the best way to cope 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 withdrawals without having to sell stocks at unreasonable prices. If your portfolio has these three characteristics, you can weather severe markets without fear or frustration.
Q: Is it too late to raise cash?
A: This seems to be a favorite question right now. Those who ask it are usually trying to decide if the damage is done or if there is room for further declines. They want some cash on hand so they can buy stocks if the market gets really cheap. It is impossible to give a one-size-fits-all answer to this question, so I usually say it depends. Do they have the resources to meet their spending needs? Do they have significant cash holdings elsewhere? How does this portfolio compare to their overall wealth position? How will the increased risk from being out of the market affect the viability of their long-term goals? If you wonder whether you should be raising cash in your portfolio, I encourage you to explore these questions with your advisor.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have about investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to firstname.lastname@example.org.