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The New Rules for Investing in a Bear Market Are Actually Old Rules

Investors are on pace for their worst year in history, declared strategists at one U.S. bank this past week. Their reasoning? Stocks and bonds are off to terrible starts, while consumer prices have roared. Extrapolate all of that bad news through to the end of the year—never mind that we’re barely halfway through spring—and diversified investors could lose nearly half their stash after inflation.

It’s possible, of course, but consider a less-dire view. Big stock downturns are normal. Since 1950, the S&P 500 index has fallen more than 20% from its high on 10 different occasions. If we lump in five cases where it came within a fraction of that mark, America seems to go through as many bear markets as presidents.

What is remarkable about the current decline isn’t its severity—the index is down 18% from its early-January high. It’s that bulls, with unprecedented help from the Federal Reserve, had it so good for so long. The average bear market during Warren Buffett’s career has taken about two years to get back to even, and a few have taken more than four years. But since today’s 35-year-olds graduated from college, no bounceback has taken longer than six months. The tech-heavy Nasdaq 100 Index has had a positive return every year since 2008.

Time to reset expectations. What follows are some new guidelines on investing, which many savers will recognize as the old ones. Momentum chasers sitting on fallen meme stocks and cryptocurrencies should resist the temptation to double down, or even hang on. On the other hand, seasoned investors who have given in to extreme bearishness should start shopping. There are plenty of good deals to be found among companies with sturdy cash flows, healthy growth, and even decent dividends.

Don’t flee stocks. They tend to outperform other asset classes over long periods, and not just because the Ibbotson chart on your financial advisor’s wall says so. Stocks represent businesses, whereas bonds are financing, and commodities are stuff. If businesses couldn’t reliably turn financing and stuff into something more valuable, there wouldn’t be so many big ones hanging around.

The problem is that the people who buy stocks can’t decide between rapture and panic, so short-term returns are anyone’s guess. Vanguard recently calculated that, since 1935, U.S. stocks have lost ground to inflation during 31% of one-year time periods, but only 11% of 10-year ones.

Cash-heavy investors should begin buying. It isn’t that things can’t get much worse; they can. The S&P 500 index is already down from over 21 times earnings at the end of last year to 17 times, but it could revert to its longer-run average of closer to 15 times, or overshoot to the downside. A prolonged market slump could create a negative wealth effect, sapping spending and company earnings and sending share prices lower still.

But trying to time the bottom is futile, and stocks can make even buyers who overpay a bit look wiser as time goes on. The average annual return for the S&P 500 since 1988 is 10.6%. Buyers who put money in when the index was trading at 17 times earnings, and held for 10 years, averaged mid- to high-single-digit returns.

Start and End Date % Price Decline From Peak to Trough Length in Days
7/15/57 – 10/22/57 20.7% 99
12/12/61 – 6/26/62 28.0 196
2/9/66 – 10/7/66 22.2 240
11/29/68 – 5/26/70 36.1 543
1/11/73 – 10/3/74 48.2 630
11/28/80 – 8/12/82 27.1 622
8/25/87 – 12/4/87 33.5 101
3/24/00 – 10/9/02 49.1 929
10/9/07 – 3/9/09 56.8 517
2/19/20 – 3/23/20 33.9 33
Average 35.6% 391

Sources: Ned Davis Research; Yardeni Research; Bloomberg

That won’t sound overly generous compared with this past week’s report of 8.3% inflation. But that figure is backward-looking, and the Federal Reserve has powerful tools to bring it lower. The relationship between yields on nominal and inflation-adjusted Treasuries implies an average inflation rate of 2.9% over the next five years, and 2.6% over the following five. Strong medicine for inflation could set off a recession. If so, it will pass. For now, jobs are abundant, wages are rising, and household and corporate balance sheets look strong.

Bullishness during downturns can seem naive. There is a tempting intellectualism to the newsletter permabears. But their long-term results are lousy. By all means, worry about war, disease, deficits, and democracy, and blame the left, the right, the lazy, the greedy—even stock market reporters if you must. But try to maintain a long-term investment mix of 60% optimism and 40% humility.


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