Updated: Sep 21, 2020
Many inexperienced investors fear the words market pullback, market correction an most often the dreaded “Bear Market”, even novice investors. It is a source of worry and panic. The questions everyone is asking: Should we just sell everything now?
Here we try to give a different perspective and why we remain optimistic….
What is a Market Pullback, Market Correction and Bear Market?
A Market Pullback is described selloff of a stock or index between 5% to 10% of a peak. There is actually no official definition. It can be attributed to a combination of profit taking and protective sell orders
Market Correction is a term representing a market loss of 10% to 20% from most recent highs.
There is official definition of a Bear Market. A Bear Market is not when stock prices end lower in the majority of trading days within a 90-day period, or a condition proclaimed by the National Bureau of Economic Research. It is also when at least two major business publications proclaim a bear market on their magazine covers. A Bear Market is therefore a downturn of 20% or more, lasting at least 60 days, in any broad equity index such as the Dow Jones Industrial Average, the Standard and Poors, or the Nasdaq. If the 20%-plus downturn lasts less than two months, it is considered a correction instead of a bear market.
Bear Markets are common and normal
Recessions and market downturns are part of a normal, healthy market cycle. such massive selloffs and allow the markets to consolidate. Investors need to accept that pullbacks and corrections are a normal part of any bull market and necessary for the sentiment to re-balance. Every bear market is preceded by a bull market that went on a little bit too long, often more than fundamentals warranted.
During the recent Bull Market between 2009 and 2020, S&P 500 has seen 13 pullbacks and 8 corrections, one of most most recent correction came during the fourth quarter of 2018 as interest rates increased and trade war tensions escalated between US and China.
Another recent correction in the S&P 500 was in 2011, when European debt fears and US Congress nearly shut down the US Government before cutting federal spending with 9 percent unemployment caused a 21.6 percent drop in the S&P500 between May and Oct. 2011. Market corrections lasts about 3-4 months on average, and take another 3-4 months to recover. Stock can fully recover after period of 6-8 months from start of correction period, In most market corrections, there is a sharp V shaped recovery, with very little bottom building or retracing.
significantly shorter than Bull Markets.
Since 1929, the U.S. stock market has experienced 25 bear markets, an average of one every 3.4 years, lasting on average 10-13 months. The 25 bull markets at that same period lasted an average of 31 months — three times as long as the average bear market. Also, the bulls sent stocks up 107% on average.
Since 1948, 8 of 11 bear markets have been followed by recessions. The average bear-market loss was 35%. The smallest loss was 21% in 1949; the most severe was a drop of 86.2% from Sep 1929 to Jun 1932 during the Great Depression.
Many investors would have recalled two fairly nasty bears in recent periods: a decline of 58% from 2000 to 2002 and a 57% plunge from 2007 to 2009. That being said, over the past 200 years, the stock market has risen more than it has declined. The bears account for only a minority in market history and are hard to predict, but they are unpleasant and hazardous to those who fail to prepare.
In comparison, Bull markets dangerous too. During bulls, volatility can also hurt short-term returns these periods.
During bears, international investors still look at US stocks for safely as U.S. economy is still considered to be the most resilient, and more funds flow to the USA equities
What causes market corrections and Bear Markets?
Market corrections can be caused by many reasons.
The bear market in 1973 was caused by geopolitical crisis when OPEC imposing an oil embargo, raising the oil price by nearly 400%. The one in 1982 followed Fed’s decision to raise interest rates in bid to halt rising inflation. Military conflict by Kuwait invasion by Iraq resulted in the bear in 1990. The bear in 2000 is caused by bursting of internet and telecom bubble while the recession of 2008 was the result tanking of housing bubble caused by an implosion of subprime mortgage. In 2011, it was caused by downgrading of US credit rating. In 2015, the banking crisis in Greece, risking its departure from the EU caused the slump, while recently, an economic slowdown in China’s exports, coupled with its unsustainable stock levels and devaluation of the renminbi (yuan) caused markets to shudder and rattled faith.
In general, bear market is triggered when investors lose faith in the market as a whole, decreasing the demand for stocks. This tends to happen when the economy enters a recession, unemployment is high and inflation is rising.
Investor Psychology also plays a part, traders are trying to guess what other investors may be thinking and react accordingly, breeding more selling. People who think other people are selling may try to get out of positions before more value is lost, depressing stock prices in the short term.
For younger investors, how would you react during Bear Market?
For younger investors in their 20-40s, they typically do not have a lump sum already invested in the market, so they would not take a severe hit. They also have decades to let their investments recover and bounce back during short term corrections and bears. It is worth buying stocks and funds now, at a lower price, and sitting on them until they rebound. A market correction or bear is actually an opportune time to ago bargain hunting and select high-quality fundamental companies, especially dividend paying ones, at an discounted value into your portfolio that could make excellent long term investments, but that previously seemed too expensive.
A stock market dip is also good reminder for long-term investors to reassess their holdings to ensure that the reason that you initial bought the stock is still valid. If your thesis is no longer intact, then it may be time to consider selling your position.
The general advice is not to make hasty decisions, be patient, and take the long view as the market recovery tend to be sharp and steep, and will come sooner than you expect. Do not try to time a bottom as it is nearly impossible.
Ensure that you are not on heavy leverage, which will magnify losses and can trigger a margin call resulting in unnecessary losses.
Protect your assets is to diversify among many equity asset classes. It is time to be more fundamental, focus less on momentum stocks. Take the longer term view, keep investing and making regular contributions This routine influx of money into your investment accounts is actually a strategy that experts call dollar-cost averaging. Half (50%) of the S&P 500 Index’s strongest days in the last 20 years occurred during a bear market. Another 30% of the market’s best days took place in the first two months of a bull market—before it was clear a bull market had begun. In other words, the best way to weather a downturn could be to stay invested since it’s difficult to time the market’s recovery.
When stocks are in free fall and there are worries in the health of the economy another way to protect your portfolio is to add government Treasury Bonds or Bond Funds. In 2008, the Bloomberg Barclays US Aggregate Bond Index, a broad-based, high-quality fixed-income benchmark gained 5%, making it the only U.S. financial asset to rise that year.
Defensive stocks like consumer staples, utilities and healthcare will lose ground in a bear market, but tend to lose less than average, supported by steady demand for their products and generous dividends. Instead, higher growth stocks would take the harder hits. Therefore, diversification across many sectors is key.
You can also include gold or gold funds as a portfolio diversifier in small amounts, as gold often rise inversely when upward when stocks drop downward.
What about older investors and those near retirement, how would you react during Bear Market?
For older investors, they are also advised to remain calm and stay focused. it is wise to hold onto the stocks and funds they have rather than cash out at low values.
Although bonds have certainly helped offer protection throughout the downturn so far, due to historic low bond yields and continuing increase in life expectancies, you might need to keep a significant portion of their portfolio in equities as well.
They can shift some asset mixes toward US stocks as the US has world’s most fundamentally stable economy. Those who want to get good quality stocks at discounted price should wait for clearer signs of stabilization before making the opportunity of the sell-off.
Having a financial plan for dealing with market declines is the best way to navigate troubled times rather than making spur-of-the-moment decisions that are off the cuff.