By Ee Hsin Kok. Edited by Arjun Chandrasekar.
Overview
The Nasdaq has just closed at $13,301 – marking a 21% drawdown from its peak and signifying the start of a bear market. On the other hand, the S&P 500 still remains in correction territory, closing at $4204, an approximate 13% decline from its peak. In the past, the S&P 500 has always followed the Nasdaq into its bear markets. This means odds are, the market will continue to fall until the S&P 500 enters a bear market as well.
Historical Context Of Bear Markets
A bear market is defined as a period where an index closes below 20% from its peak. Over the last 75 years, there have been 14 bear markets. This means that on average, they occur about once every 5 years. The most recent bear market was 2 years ago in 2020. It was also the quickest drop in bear market history – the market fell almost 36% from its peak within just 6 weeks.
Bear markets also tend to last around 11 months, and the average drawdown is between 32-36%. The biggest bear market in recent history was in 2008, brought about by the Great Financial Crisis and it caused a 57% decline in the S&P 500.
Should You Be Concerned?
Bear markets mean massive drawdowns for portfolios and massive unrealized losses in the short term. This is a scary situation for investors, but should you be losing sleep over it? Well, maybe.
There are three scenarios that SHOULD cause you to be concerned about the impending bear market:
- You are over-leveraged
- You invested with money you need in the short term
- You’re holding bad companies
The first is if you are over-leveraged. Leverage allows investors to buy more than they have, which is good when markets are going up. But they’re a double-edged sword, and in the event of massive drawdowns, margin calls by your broker will likely force you to sell at the bottom.
The second situation would be if you are investing with money you need in the short term (within the next 1-3 years). Bear markets last 11 months on average and can be as long as 1 year 10 months. If you’re investing with money you need within the next 1-3 years, you may be forced to sell near the bottom, or before the market has fully recovered.
The third situation would be if you are holding bad companies. During a bull market, everyone’s a genius. Both bad and great companies will experience massive gains. However, the value becomes a lot more important when the bear market rolls around. Weak companies will be sold off when they are unable to meet expectations and improve their financials. More crucially, it is these weak companies that will be left behind when the market rebounds. On the other hand, the great companies that represented fantastic value opportunities during the bear market will bounce back even stronger.
Capitalizing on a Bear Market
Psychologically, the first bear market is often the hardest. Amidst a sea of red in your portfolio, it can be hard not to panic. So if you are panicking, remember that bear markets don’t last forever, they rarely last longer than a year and never more than 2. History has shown us that the stock market often has to take 1 step backward before it takes 3 steps forward.
In order to capitalize, you’ll want to add great companies at the massively discounted share prices caused by the bear market sell-offs. Look objectively at each and every one of your positions. Identify the stocks you bought simply because they were hyped, and the ones that are legitimately good companies. Sell off those positions you don’t have a strong conviction in, and continue adding shares to the positions you do believe in. If your portfolio is not diversified enough, this can also be a time to buy into a fantastic company in a new industry or sector at a great discount. Though don’t get carried away with this, oftentimes the best stock you can buy is one you already own.
In conclusion, you can capitalize on this bear market by holding a diversified portfolio of strong companies, which you can continue to add in stages as prices fall and invest only with money you have and won’t need anytime soon. If you follow these steps, you should come out of the bear market on top, with a portfolio that’s stronger than ever.
