Market Notes | Avoid the Bear Trap

Idea in brief:

• Financial markets are more predictable than most realize
• Bear markets become bull markets, and pessimism becomes optimism
• The greatest danger is being out of the market

The Wall Street Journal Business & Finance section on Monday morning had the headline “Market Plummet Alters Investor Behavior…Options Buzz Fades…Cryptocurrencies Slide…Pessimism Grows.” The article mentions that widespread pessimism is not necessarily bad news. Some analysts view the results from the AAII Sentiment Survey and postulate that “markets are poised for a rebound.” (Back in 2009, the S&P 500 hit its financial crisis closing low just four days after the AAII Reading.)

We all have a difficult time handling uncertainty. So how are we to make intelligent decisions when everything seems uncertain? The good news is that many important aspects of the financial markets are much more predictable than you realize; certain patterns tend to repeat again and again. The ability to invest without fear and avoid the bear trap is critically important.

On average, corrections occur once every 2.9 years¹

Instead of getting distracted by the Merchants of Doom, by all the noise and click bait, focus on a few key facts that truly matter. For example, according to the CFRA, of the 23 corrections in the post war-era, the S&P 500 sustained an average loss of 14.0 percent and dragged on for 135 days, or roughly four months². After hitting a low, it takes the market an average of 116 days, or less than 4 months, to get back to even.

The stock market rises over time despite many short-term setbacks

Declines in the range of -5.0 to -10.0 percent occur once every 11.3 months. In other words, these market drops are regular occurrences. From peak to peak, the average is 2.47 months³. As of March 31, 2022, the 10-year S&P 500 return was 14.6 percent⁴. Why is this so important? Because it reminds us that the market generally rises over the long run – even though we hit a huge number of potholes along the way.

It’s worth mentioning that the US stock market typically rises over time because the economy expands as American companies continue to become more profitable, as American workers become more efficient and productive, and as technology drives new innovation.

But what if America’s future is lousy? It is a fair question. We all know there are strong headwinds. Even so, we have an incredibly dynamic and resilient economy with some powerful trends driving future growth. In an earlier annual report, Warren Buffett addresses this subject explaining how population growth and extraordinary gains in productivity will create an enormous increase of wealth for the next generation, “This all-powerful trend is certain to continue: America’s economic magic remains alive and well,” he wrote. “For over 240 years, it’s been a terrible mistake to bet against America, and now is no time to start.”

S&P 500 Index at Inflection Points⁵

Historically, bear markets have happened every 7 years⁶

Just to recap for a moment, corrections happen regularly. Nobody can predict when they happen. The market usually rebounds quickly and resumes its general upward trajectory. Any fear you once had should turn to power.

But what about bear markets? Shouldn’t we be terrified of them? Actually, no. Here again, we need a few key facts so that we can act on knowledge, not emotion. The first fact you need to know is that there were 34 bear markets in the 115 years between 1900 and 2015. More recently, bear markets occur roughly once every 7 years⁷. The future will not be an exact replica of the past. Still, it’s useful to study the past to gain a broad understanding of these recurring patterns or rhythms of the market.

Here is what you need to know: bear markets don’t last. When we are in a bear market, you will notice that most of the people around you become consumed with pessimism. They believe that the market will never rise again and that their unrealized losses will only deepen. The most successful investors take advantage of the fear and gloom to invest more money, rebalance portfolios at bargain prices as well as create tax assets for future use. One of the greatest investors of the last century, Sir John Templeton, explained: “The greatest opportunities come in times of maximum pessimism.”

Bear markets become bull markets, and pessimism becomes optimism

The pattern of bear markets suddenly giving way to bull markets has repeated itself again and again in America over the last 75 years. In fact, every single bear market has been followed by a bull market, without exception.

“The stock market is a device for transferring money from the impatient to the patient.”
-Warren Buffett

The greatest danger is being out of the market

It’s not possible to jump in and out of the market successfully. It’s much too difficult for mortals like you and me to predict the market’s day-to-day movements. As Jack Bogle once said, “The idea that a bell rings to signal when investors should get into or out of the stock market is simply not credible.”

The trouble is, sitting on the sidelines even for short periods of time may be the costliest mistake of all. I know this sounds counterintuitive, but as you can see in the chart⁸ below, it has a devastating impact on your returns when you miss a few of the market’s best trading days.

Of note, a study by JPMorgan found that 6 of the 10 best days in the market over the past 20 years occurred within 2 weeks of the 10 worst days. The moral of the story: if you made an emotional decision and sold at the wrong time, you missed out on the fabulous days that followed, which is when patient investors made substantially all of their profits.

In other words, market turmoil isn’t something to fear. It’s the greatest opportunity to accelerate financial freedom. To put it another way, fear isn’t rewarded. Courage is.

The message is clear, the greatest danger to your career, life, and wealth goal achievement isn’t a bear market; it’s being out of the market.

In fact, one of the most fundamental rules for achieving investment success and long-term wealth creation is that you need to get in the market and stay in it, so that you can capture all its gains and benefit from the magic of compounding. The worst performing strategy in the chart above is the one which stayed on the bench, the one in cash; that strategy ended up with only $53,304.

Remember, based on financial history, you now understand that corrections, bear markets and recoveries follow similar patterns again and again. Now that you have the power to recognize these long-term patterns or rhythms of the market, you will also have the power to utilize them and avoid the bear trap.

Knowledge brings understanding, and understanding brings resolve. Thank you for your continuing trust and confidence in Stonebridge.

Cheering you on,

Mitch Martin

¹ Standard & Poor’s Corporation and Crandall Pierce & Company
² CFRA provides independent and actionable research and analytics to global subscribers improving their investment and business decisions.
³ Standard & Poor’s Corporation and Crandall Pierce & Company
⁴ Callan
⁵ JP Morgan Asset Management, Compustat, FactSet, Federal Reserve, Refinitive Datastream and Standard & Poor’s Corporation
⁶ Standard & Poor’s Corporation and Crandall Pierce & Company
⁷ Standard & Poor’s Corporation and Crandall Pierce & Company
⁸ Callan