What are bull and bear markets?
When the stock market moves at an upward trend, this is referred to as the Bull market and when the market moves on a downward trend, it’s a Bear market.
Navigating Market Uncertainty (a Bear Market)
Global stock markets are pulling back after hitting new all-time highs at the end of 2021. Could this be the end of the 11-year bull market we have been in? With elevated inflation, the Federal Reserve appears ready to remove the punch bowl by increasing rates and ending QE. Geopolitical tensions over Russia and Ukraine and more lockdowns, as is happening in China, add to the uncertainties.
Many of the high-flying US technology stocks that had powered the markets higher are down by 50% or more, The Nasdaq 100 is down 25%, S&P 500 15% while the Top 40 is only down 5%.
With so many uncertainties it is no wonder investors are struggling to assess whether this might be another short-lived decline or the beginning of a more protracted downturn. And in either case what can be done about it?
Managing Risk through Diversification
Volatility is a normal part of investing, as is its second derivative increasing/decreasing rates of volatility. We have been in a period of low volatility and where the rate of change of this volatility has been low. This has changed recently.
That said, long-term investing success requires withstanding these challenging periods. One way to do this, while maintaining your mental capital (ie less emotional stress), is via diversification.
An investor can dial up/down their portfolio by holding more/less equities in relation to cash and bonds. Within equities, diversification can be obtained by investing in a variety of sectors and thus not being exposed too much to any one part of the economy. For example, within your portfolio you can have exposure to financial companies, technology and energy and not just financials alone (and even with financials you can have exposure to banks, short term and long term insurers and not just retail banking alone).
Instead of gaining diversification by investing in a broad range of industries an investor can get this by investing in a range of companies exhibiting value, momentum, quality, and stability characteristics.
By investing in a broad portfolio, you can lower your risk and increase your long term expected return. You can see this by noting that the Top 40 has a total return of around -5% (as of 16/05/2022) and comparing this to our bundles where Momentum has a 15% return, Value 6.6% return, Quality 0.3% return while Stability is down -6.7%.
Timing factors is almost as hard as timing the overall market but the point being that a diversified portfolio can be created that, over the long term, will outperform. This leads us into the point below that there is always opportunity somewhere in the market.
There is always Opportunity Somewhere
A change in market environment often means a change in the market leaders in the market. For the last 12 years this has been technology companies. Lately materials and energy have been outperforming. There is a host of reasons for this which include the sanctions in Russia, the green revolution and obtaining the necessary resources to power this and the under-investment in exploration in the last ten years to name a few. A bear market usually leads to consumer staples outperforming consumer discretionary goods and there are other such investment strategies that are open.
In SA, while the overall market is down, a diversified portfolio of momentum and value companies are outperforming. The SWIX energy sector is up 69% year to date, consumer staples are up 6% while health care is down 18% and consumer discretionary is down 28%.
How long is an open question, but the point being that there are strategies that work in a bear market just as there are strategies for a bull market. Long term it can be argued that technology will continue to disrupt even more parts of the economy and technology is itself disinflationary. So, an investor could try to invest to optimise for each cycle or just have a much longer time frame of 10 years plus in which case today’s lower prices in sectors that have taken a hit, represent an opportunity for the long term and thus the heightened volatility isn’t a concern.
Time in the Market VS Timing the Market
Bear markets have historically been shorter than bull markets. The average US bear market, since the 1960s, has lasted approximately 15 months and resulted in a 38% decline (according to JP Morgan). While the average bull market has lasted nearly six years, with an approximate 210% return.
Or looking at it another way. Had you invested at the height before the 2008 crises (approximately June 2008), at the worst point you would have been down, -48% in the Top 40, -25% in the Nasdaq 100 and -32% in the S&P 500 index (all in ZAR). Additionally, you would not have recovered those losses until mid-2011, approximately 3 years later.
But had you held on until today, 17/05/2022, an investor would have achieved a return of 1416% cumulative return on the Nasdaq 100, 709% return in the S&P 500 and 205% return on the Top 40 (all in ZAR).
Now the past does not imply anything about the future and if an investor could time the top and bottom perfectly then they would be better off.
Market timers risk missing the rebound. Selling in a panic amid a market decline typically means locking in short-term losses and getting off track from your longer-term plan. Staying the course, while maintaining diversification and rebalancing your allocation can be the smarter strategy.
The biggest gains often come in the early stages of a recovery and missing even just the first month of gains can have a big effect on future performance. As shown below, missing just the top 10 days in the market over the past 20 years would have cut annualized returns by nearly half.
Yes, this argument is even more pronounced the other way around, for example in the decade starting 2010 the S&P 500 produced a total return of 190%, had you missed the 10 worst trading days you would have achieved a 351% return, but had you missed the ten best days you would have had a 95% return. However, since an investor can never know which ten days out of a decade are going to be the ten best days, any more than an investor can know which will be the ten worst days, it makes sense to stay invested throughout, provided your portfolio is consistently risk managed.
All data from Bloomberg*
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