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What to remember about bear markets

With markets currently volatile, Joe Wiggins, Director of Liquid Markets at St. James’s Place, examines some of the key characteristics of a ‘bear market’

Bear markets — a time when stock markets fall — are an inescapable feature of stock investing. They are also the biggest challenge investors will face. It is not because of the (hopefully temporary) losses that will be suffered, but of the bad choices we are likely to make during them. Bear markets completely change the dynamics of decision-making. In a bear market, smart long-term decisions often seem foolish in the short term; whereas in a bull market, foolish long-term decisions often seem smart in the short term.

If we are to enjoy long-term investment success, we must be able to navigate such demanding times. There are some characteristics of bear markets worth remembering:

They are inevitable

Bear markets are an ingrained aspect of stock investing. We know they will happen; we simply cannot know when or why. That they happen should come as no surprise. The long-term return on holding stocks would be significantly lower if there were no bear markets.

It will feel predictable

As stock prices fall, the look-back bias will be unleashed. It will seem obvious that this environment was coming – the warning signs were everywhere. We will blithely ignore all the other periods when the red flags were abundant and no market declines took place.

We won’t call the bottom

Market timing is impossible, and this fact does not change during a bear market. The only difference is that the lure of attempting it when portfolio values ​​drop can become overwhelming, and the damage it inflicts will likely be greater than usual.

Economic and market news will be confused

The temptation to intertwine economic developments with the outlook for stock market performance can become irresistible during a bear market. Bad economic news will make us increasingly worried about the markets, even if that relationship is (at best) incredibly tenuous.

Our time horizons will contract

Bear markets cause panic, which means our time horizons shorten considerably. We stop worrying about the value of our portfolio in thirty years and start thinking about the next thirty minutes. Being a long-term investor becomes even more difficult during a bear market.

We will not consider what a bear market really means

In the short term, bear markets are about painful and worrisome portfolio losses, but what they really are is a reassessment of the long term cash flows generated by a company/the market. The underlying value of these companies does not change as much as short-term market prices.

Lower prices are good for long-term savers

For young investors who save for the long term, falling market prices are attractive and good for long-term results (it just won’t feel like it).

Some losses will not be temporary

For reasonably diversified long-term investors, losses in most bear markets should be temporary (there is a long-term premium attached to investing in stocks after all), but we shouldn’t naively assume that all is well. recover. Misguided or ill-conceived investment decisions will be exposed in bear markets. Improper leverage, unnecessary focus and exorbitant valuations tend to lead to permanent capital losses that time will not heal.
movements will dominate

Our ability to make good long-term decisions during a bear market is severely compromised. Rational thinking will be overcome by the emotional tensions we are likely to feel – what if things keep getting worse and I haven’t done anything about it? It’s during these times that systematic decision-making — like rebalancing and saving regularly — comes to the fore.

Our risk tolerance will be reviewed

Bear markets are the worst possible time to know our risk tolerance. Everyone becomes risk averse when they lose money. The problem for investors is that experiencing a 37% loss is a much different proposition than seeing it presented as a hypothetical scenario. Whenever possible, we should avoid reassessing our risk appetite during difficult times.

we will extrapolate

During a bear market, it’s hard to see anything but relentless negativity. Our tendency will be to believe that things will continue to deteriorate – prices will be even lower tomorrow.

Every bear market will be different

We should ignore all charts comparing current declines with other bear markets in history, they are totally useless. There is no reason to believe that such a deeply complex and unpredictable system should mimic the patterns of the past. Every bear market is unfortunate in its own way.

Bear markets are the ultimate behavioral test

The results of bear markets concern us more than they concern the market. Investors entering a bear market with identical portfolios will experience wildly different outcomes depending on the decisions they make during the bear market.

Bearish stock markets make all the usual challenges of a long-term investor all the more difficult. The noise of daily market fluctuations will become deafening, we will check our portfolios even more frequently and may feel the urge to make irresistible short-term trades.

Good financial advice can help you drown out some of that noise and keep thinking about the long term when considering investment decisions.

Joe Wiggins is Director of Liquid Markets at St. James’s Place.

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