At first glance, the question above seems simple enough. However, answering it is more convoluted than one can imagine. In the first instance, why should the answer be any different if the above question was reversed to sound like the following: “How to invest in a bull market?”
Before I begin, investors would do well to remember that the share market is not a casino nor should it be treated as one by speculating about the best times to enter the market.
What is a bear market and what causes these wild market fluctuations?
These days, with share prices dropping, media publications have come up with headline after headline that we are now officially in a bear market.
Now, what is a textbook definition of a bear market? A bear market occurs when the broad-base equity index trades 20% below the all-time high.
Read the line above again and tell me what is the one term that really stands out in the whole sentence. Hint: it’s not the bear. Personally, I think the majority would tend to focus on the term “20% below”.
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To me, the key words of the above sentence are "all-time high".
This phenomenon is what we (in financial circles) term as an upside bias. In layman's terms, ‘up’ is always good news and ‘down’ is never good news. So even if the share market was seriously ahead of itself (or overvalued) by 20%, there will be so-called gurus who will attempt to justify why it is currently fairly valued with more upside on the way. You can call these gurus permabulls. Of course, there are some opposing views of reason but their voices are often drowned out by the deafening sounds of pounding huffs during typical bull runs.
On the flip side, the phenomenon also holds true. It is called the downside bias where the naysayers (permabears) will have a field day with the media in tow. You can virtually read or hear it every day, be it on social media or any of the major financial news outlets. It will be screaming something like “Dow Jones has another 50% or more to fall" (although, we hope it doesn't come true).
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Essentially the message here is that while as much blame is to be put on market participants for these wild market swings, the media is equally guilty of adding fuel to the fire.
So why are we in a bear market today?
The decline in share markets has been precipitated by high inflation, which was a direct consequence of unbridled monetary and fiscal stimulus added by central banks and governments during the pandemic. Supply chain disruptions and the Ukraine war have only served to further exacerbate the inflationary pressures. Inflation is seen as a bane for long-term economic growth.
To combat inflationary pressures central banks around the world (including the Fed) have started increasing interest rates at an unprecedented pace to get ahead of inflationary expectations. Investors are concerned that the higher interest rate environment and any subsequent recession thereafter will depress corporate revenue and earnings. All the cumulative events combined have been the primary catalyst for the recent decline of equities into bear market territory.
Should I be worried about a bear market?
Absolutely not. For convenience’s sake let’s name the share market as Mr Market. The reality of it all is that Mr Market is just doing what it was supposed to do. It is behaving perfectly normal (with the occasional wild gyrations) as it has been doing since the great crash of 1929 which precipitated the Great Depression.
You must understand that Mr Market is always on an upward trajectory but not in a straight-line linear curve. It never does by design or does not know how to by default. It does, however, love to overshoot on the way up or down, especially when asset prices are decoupled from intrinsic values and that is just Mr Market being Mr Market. Mr Market was born with a “bipolar disorder” to sum it up best in medical terms.
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Ok we are now here, what should we do?
My belief is that the investment time horizon should be forever when selecting individual stocks (preferably broad-based exchange-traded funds or ETFs). I will only recommend exits should the primary fundamentals of the company change and deteriorate for the worse.
The basics of investing start and end with fundamentals. Investing for the long-term, in the manner of Warren Buffett, involves selecting great businesses and buying them at a fair price or better still below intrinsic value. Of course, it is much easier to find great companies selling at a discount to their intrinsic value during a bear market as opposed to a bull market but essentially the basic tenets hold true regardless of market conditions.
I do have one caveat though. Finding those companies and buying them at a good price is easier said than done, almost akin to finding a needle in a haystack. It inherently involves a thorough understanding of many different variables within the fields of macroeconomics, geopolitics, the industry and of course the company itself, in order to be mildly successful at stock picking. Not an impossible task for the average investor but it does involve a lot of homework. It would be better, in my opinion, to leave that to the professional fund managers or alternatively invest directly in a broad-base ETF (QQQ or VOO) giving you instant diversification and exposure to the best companies on the planet.
On another note, what you should do is also highly dependent on your individual financial situation.
For those who are already fully invested with a well-diversified portfolio and no more additional funds to invest…do nothing. Read on and be heartened later.
For those who are already invested with a well-diversified portfolio but still earning an income and/or have additional excess funds sitting in cash, continue to invest consistently. As a matter of fact, it would be advisable to pick up the pace now with great companies or ETFs selling at a discount.
For those who have been watching from the sidelines and have not yet entered the market, this is a perfect opportunity to do so. You should be getting in now as the prices are lower than usual in a bear market. Although my primary message here is to ignore market gyrations over the long term, that does not mean you cannot take advantage when the opportunity presents itself.
Can the market fall further?
Yes absolutely! But I cannot tell you whether it will fall further for sure or not. It is virtually impossible to predict when the markets bottom out. Your guess is as good as mine; I do not have a crystal ball and no one does. All I can tell you is that the current overall valuations are not as frothy as they were compared to the same time last year and some fantastic companies are indeed trading well below their long-term averages. Again, if you are looking for an excuse not to invest now, maybe you should never invest in equities unless you are in for a quick punt.
Barring any unforeseen global events, my best educated guess reading into multiple economic and geopolitical indicators, I would be cautiously optimistic in the next six to 12 months ahead. Having said that, should a black swan event occur (such as Russia escalating the war with Ukraine and, or China invading Taiwan), then all bets are off.
What does history tell us?
I know that bear markets are no fun to say the least but do you really want to sell your holdings or stay on the sidelines in this current market downturn? Let’s recap on all the excuses you can conjure up to justify selling or not investing. War, Covid lockdowns, inflation, increasing interest rates, suppressed consumer or business sentiment, yield curve inversions…there are always plenty of reasons to sell. Before you hit the sell button, take a breather and look at what history can teach us.
History is often regarded as the ultimate arbiter of facts and evidence. Market downturns occur frequently and every time that happens, permabears on Wall Street (and the media too) will be screaming “It’s different this time. This is the big one. Sell before it’s too late!”. But, time and time again, history has proven them wrong (with evidence) as the market always recovers.
Since 2009, every single time the market drops (along with multiple reasons why you should sell), it eventually recovers to surpass previous highs. Whatl I am trying to say here, is that you can, and should take advantage of the current bear market to buy great companies (or ETFs) at great prices.
What we are experiencing now is just another one of those downturns. As a reminder, these events are all but a passing moment. The war in Ukraine will eventually resolve itself. China’s zero-Covid policy is economically and politically unsustainable and will be seconded to the history books by the end of this year. Inflation is already on its way down and the Fed will pivot to a dovish policy sooner than the market is expecting.
Here is further historical proof of rolling average returns from 1937 to 2021 for the S&P 500. While I cannot make any short-term predictions about likely market returns, these charts do give me confidence that the market will over the medium to long-term time horizon, rebounding from its current malaise. To be a successful investor, patience is required. History has shown that a well-diversified portfolio of quality investments will inevitably do well.
In conclusion...
I would like to take you on an imaginary journey with me to a theme park located on 11 Wall St, New York. The star attraction there is their signature roller coaster ride called the DJIX. At the gates of the ride, it has a big sign with a tagline which reads “The scariest and yet most rewarding ride of a lifetime.”
You pay $1 at the ticket booth and at the end of the ride you will get $10 as a reward. It comes with caveat emptor - you can get off at any time at your own risk. What do you think will happen should you decide to jump off during one of those scary drops? At best you will end up with a few bruises. More likely you will end up scared.
Investing in the equity markets is akin to riding the scariest roller coaster ride of your lifetime. Scary as it is, yet exciting and rewarding nonetheless. That is the price of entry. You have already paid for the ticket and may potentially get a 10x return at the end, so might as well just hang in there and enjoy the ride!
Weiyang is an aspiring analyst in the fields of investment banking and private equity. He is currently an undergraduate at the National University of Singapore (NUS). He is also an equity research analyst at NUS Investment Society and serves as a macroeconomics analyst for the Victoria Investment Charitable Trust Fund.
