Navigating the Bear Market

Investor nerves are running high. It is a question that seems to arise with more frequency during times such as these. “With the market moving lower day after day, should I pull my money out of the market?” While the urge to flee the market is certainly understandable, it is typically not the best move to exit in the midst of a prolonged decline. Even if you have decided that you’ve had enough of the market volatility and need to head to the sidelines, showing some patience before executing such a move is typically rewarded.

Bear markets do not move lower in a straight line. Although it may feel this way when you’re going through it, bear markets instead move lower in a series of steep declines followed by sharp rallies. For example, although the current bear market is now down over –20% from its October 2007 peak, it has been anything but a straight path down to arrive at this point (see chart). Instead, the market has had an up and down ride along the way including five corrections ranging from –5% to –15% and four rallies ranging from +4% to +12%.

click to enlarge

Even bear markets offer opportunities. Bear markets and their associated volatility provide fertile times for active managers to add value. Those investors that have the discipline to build selected positions in the face of heavy market headwinds and sell these same positions amid the rush of a market rally can be handsomely rewarded. Of course, such an approach is also fraught with significant risk. As a result, trying to time the market during a bear phase should be reserved for the more aggressive investors that have a well-defined buy and sell discipline and the ability to sustain some potential setbacks along the way.

The beleaguered investor seeking to move to the sidelines can also find some relief. If you have decided that it is time to exit the market and head to higher ground for the time being, you are typically best to resist making such a move in the midst of a prolonged correction. For example, the current market has declined nearly –15% since mid May. This latest correction is already fairly long and deep by the standards of a typical bear market. As a result, it would not be surprising to see the market soon enter into a rally phase. Given that the typical bear market rally will retrace anywhere between 35% to 65% of its previous correction, it would not be unreasonable to see a +5% to +10% rally on the market if it were started today. Thus, the patience to wait on moving to the sidelines until a bear market rally phase has taken hold is typically worthwhile.

Conclusion: Bear markets provide attractive opportunities for active managers. And those investors seeking to get out of the market are typically best served by not exiting during a bear market corrective phase but instead having the patience to wait until a bear market rally phase.

Disclosure: None

Comments

[adan]

really nice chart and thoughts, thanks

[jim_curtis]

are you nuts? what are you saying? hold em f they go down? sell em if they go up? is that the plan? if it is why not just send the money somewhere where it will do some good? i suggest you read gerald lobe's "battle for investment survival" and give yourself a chance to make some money or at least give yourself a chance not to lose it all. best wishes

[John Egan]

Looks to me like he's saying "Buy on the dips and sell on the news".... And go short when trending down. In other words, take advantage of the shorter term trends for trades and long term trends for holds.

Bye jegan ;-)