It might seem hard to believe, considering how stocks have been thumped by the coronavirus-induced recession, but bear markets can be moments of opportunity. Down markets are, of course, typically associated with volatile share prices, conflicting economic signals and pinballing investor sentiment. Under the surface, however, these periods have often laid the economic and financial foundation for the market recoveries that followed.
For investors to benefit from periods like this, a clear lesson from the past is not to overreact to passing events or fleeting headlines. In other words, investors who stick to carefully conceived long-term plans can be rewarded if markets bounce back.
To remain focused on the long term, it can help to consider some basic lessons gleaned from market recoveries.
A fundamental element of bear markets is that they have been relatively short compared with recoveries. Bears also have had a relatively modest impact compared with the long-term power of bull markets.
Every market decline is unique, and the past does not predict the future. However, since 1950, the average bear market has lasted 14 months. The average bull market has been more than five times longer.
Historically, the impact on returns has been just as dramatic, with the average bull market notching a 279% gain. However, recoveries are rarely a smooth ride. Investors must often withstand scary headlines, significant market volatility and additional equity declines along the way. But investors who remain focused on the long term are often better equipped to disregard the noise and stick to their plans.
It’s impossible to know what the next recovery will look like, but historically stocks have often recovered sharply following steep downturns. Consider the five biggest market declines since the Great Depression. In each case, the S&P 500 index was higher five years later. Returns over those five-year periods averaged more than 23% per year.
Returns have often been strongest after the steepest declines, bouncing back quickly from market bottoms.
In the past 90 years, the first year following the five biggest bear markets averaged 71%, underscoring the importance of staying invested and avoiding the urge to abandon stocks during market volatility. Although these have been the average returns during recoveries, each one has differed and it’s quite possible any future recovery could be more muted.
Many companies got their start during tough economic periods and went on to become household names. To highlight just a few: McDonald’s emerged in 1948 following a downturn caused by the U.S. government’s demobilization from a wartime economy. Walmart came along 14 years later, around the time of the Flash Crash of 1962, a period when the S&P 500 declined more than 22%. Airbus, Microsoft and Starbucks were founded during the stagflation era of the 1970s, a decade marked by two recessions and one of the worst bear markets in U.S. history. Not long after that, Steve Jobs walked into his garage and started a small computer company called Apple.
History has shown that strong businesses find a way to survive and even thrive when times are tough. Those that can adapt to difficult conditions and become stronger have often made attractive long-term investments. Bottom-up, fundamental research is key to identifying companies that may help lead a market recovery — and those that are more likely to be left behind.
It’s time, not timing, that matters in investing. Taking your money out of the market on the way down means that if you don’t get back in at exactly the right time, you can’t capture the full benefit of any recovery.
Consider the example of a hypothetical investor who sold stocks during the market downturn of 2008–2009 and then tried to time the market, jumping back in when it showed signs of improvement. Missing even the 10 best days of the recovery would have significantly hurt that investor’s long-term results — and the more missed “good” days, the more missed opportunities.
In volatile markets, investors who are hesitant to put all their excess capital to work at once, but have the fortitude to make investments when markets are declining, may want to consider dollar-cost averaging. During a decline, dollar-cost averaging allows you to purchase more shares at a lower average cost; when markets eventually rise, those extra shares can enhance your portfolio’s value.
Today’s economic and market challenges may seem unprecedented, but a look through history shows there have always been reasons not to invest. Despite negative headlines, the market’s long-term trend has always been higher.
Consider a hypothetical investment in the S&P 500 on the day Pearl Harbor was bombed, December 7, 1941. Someone who stayed invested for the next 10 years would have averaged a 16% annual return. Likewise, a hypothetical $10,000 investment in the S&P 500 on the day Lehman Brothers declared bankruptcy — September 15, 2008 — would have grown to more than $30,000 10 years later.
Great investment opportunities often emerge when investors are feeling most pessimistic. The coronavirus outbreak may be unlike anything we have faced before, but uncertainty is nothing new to the market, which has been resilient over time. Remember that bear markets don’t last forever.