Investment Research Group
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Bear markets are nasty things, but the good news is that they seldom last more than 24 months. The really bad ones, such as the market decline of the 1970s, lasted over seven years and was so bad that it forced fund managers to redefine their investment strategies.
They began to reread the theories surrounding efficient portfolio management that had been set down 20 years previously by Harry Markowitz. This set down, among other things, how risk can be balanced in a portfolio so that the portfolio is efficient and no one event can destroy the portfolio.
Historically, major bear markets have followed a pattern In the first phase there is a sharp initial fall that removes much of the speculative froth from the market. That is followed by the middle phase where there is a strong rally in prices for several months, which may lull some investors into thinking that the bear market is over.
This is quite a dangerous phase where “bargain hunters” enter to snap up cheap looking shares, which are in effect not cheap given the rising market risks.
The rallies can be dramatic, but have lower trading volume than the initial sell-offs.
And the advances tend to be concentrated on a few selected shares, not the whole market.
In the third phase there is a long slow downward grind in prices, accompanied by low volume and periodic false recoveries. The bear phase ends quietly as share valuations reach rock bottom.
At this point, few investors from the earlier buoyant phase in the market are interested in anything other than the most conservative investments.
Once started, bear markets rarely finish without at least a 40% decline in prices from the previous bull market peak. The bottom of the early 1970's bear was 50% below the peak.
The average length of bear markets is frequently said to be around 16 months. But major bear markets typically occur after a decade of rising share prices, and can last a lot longer.
Markets are driven by fear and greed. The top of a bull market is marked by a climate of greed and exuberance, and the bottom of a bear market is marked by a climate of fear and pessimism.
But this has to end sometime, and in the past the key signal is when nobody wants to go near the market, investors sell out and vow not to return and shares are trading at prices that deliver very good dividend yields.
When markets turn from bull to bear, you have various options. The first is to “cut and run” sell all your shares with a promise you will buy back when the market turns. This is a timing strategy that is very hard to get right.
Another approach is to “sit tight:” hold all your shares and wait for the recovery. You then won’t miss the upturn when it eventually does come.
A more balanced approach is hold onto much of your portfolio but sell the most vulnerable and turn part of the portfolio into cash ready to reinvest in the future.
