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Bear attacks are not typically drawn-out affairs. Victims are savagely clawed to the ground, where they are either dead or left for dead in a matter of minutes. Bear markets (named after the downward motion of an attacking bear claw, according to Street lore) are different beasts. They start with a 15% to 20% drop in stock valuations — then leave their wounded wondering for months on end whether another vicious pummelling is on the way.
There is no question that bear markets are the best time to invest, because fear freezes most investors like deer caught in traffic headlights. They don’t want to buy into a sucker rally, or what the Street calls a “dead cat bounce.” So they wait for solid signs of the market hitting bottom. If you have a limited taste for risk, a conservative rule of thumb says it is safe to jump back into equity markets after a major correction when a 5% to 10% market rally holds water for more than a few months. Waiting with the herd, however, pretty much guarantees you’ll jump on a new bull that is already out of the gate, not play the bear. And while bull runs (named after the upward head thrust of attacking bulls — again, according to lore) can make you money, the simple act of waiting for safety tramples your chances to make a killing. Indeed, as Michael Zhuang — a self-proclaimed “investment scientist” and blogger based in Washington, D.C. — points out, the S&P 500 rebounded by between 23% and 42% eight times in the 12-month periods following its 10 largest three-month selloffs (declines ranging from 13% to 30%) since 1950. (Small-cap value stocks did even better.)
Nobody rings a bell when bear markets are ready to hibernate. Professional bottom watchers will offer advice. But they are as reliable as people who sell blackjack systems. That said, volatility is frequently used to track the migration patterns of bulls and bears. MarketWatch columnist Mark Hulbert, for example, recently pointed out that the Dow has jumped or tanked by 2% on a single day at least eight times since all hell broke loose late last year. That never happened in 2006 and happened just once in 2005. According to Hulbert, this sort of extreme volatility, more often than not, marks a bear’s bottom.
If that’s the case, then we’ve just been attacked by Gentle Ben. After all, over the past 50 years the average price decline during historical bear markets on the S&P 500 has been about 32%. And no major North American index was even in solid bear territory (down 20% from 52-week highs) as I pen this column in mid-February. Nevertheless, as Hulbert notes, the last time markets were this jumpy was in early 2003, when the Dow retested its low of October 2002. That dispatched the 2000 bear market and let loose the five-year bull that now seems to be on life support.
If you think another Depression is on the way, forget stocks. If not, keep in mind that conservative forward-looking estimates of the equity risk premium (expected return on stocks minus expected returns on risk-free bonds) on S&P 500 stocks says now is a good time to buy.
If current earnings estimates are accurate, these stocks should pay you at least 2.5% more annually than riskless U.S. T-notes. And don’t forget the potential impact of exchange rates. Any American stocks you buy with the Canadian dollar around par have a good chance of increasing in value by 10% — if the U.S. price of the loonie declines to where economists say it should.
David Kotok, a New Jersey–based fund manager, thinks America will avert a serious recession. He notes that Washington is tossing a stimulus package at the economy, which has also been fuelled by five interest rate cuts since September, including a 125-basis-point reduction in January. Furthermore, theLondon Interbank Offered Rate has settled down. And when it drops, Kotok says the value of trillions of dollars’ worth of long-duration assets will increase: “The stage is set for global asset revaluation upward by about US$50 trillion. That will be spread among real estate, stocks and bonds.”
Kotok, of course, also expects markets to retest recent lows, since reversals have triggered retests in nearly every case over the past half century. And they typically come between two weeks and five months after a major sell-off.
So watch, and wait. If a real bear rears its head, don’t freeze. Remember that almost every bear market in recent history has been followed by a bull that eventually jumped over the previous market top. Give fear time to do its thing. And when you are ready to place some bets, keep dividend stocks in mind.
According to Bryan Taylor, president of L.A.-based Global Financial Data, real return data show bear markets are not as scary as most people think. Indeed, when dividends are factored in, the average S&P 500 bear market of the 20th century lasted just over one year. The shortest lasted less than two months; the longest was 42 months.
Whatever you do, never forget that Street-smart folks like Warren Buffett won’t tell you that stock markets look good again until after they’re back in. And guys like me wouldn’t be writing for a living if we could make a better one by playing the markets.
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