(We’ll look at this in more detail in Chapter 2, “Investing as a Contact
Sport.”) If you look at those nine modern bear markets beginning in 1956
and ending in 1990, you will notice that during this 34-year period, investors
have struggled with bear markets about 25 percent of the time.
Contrast that with the 10-year uninterrupted run of the last bull market,
and it’s easy to see how investors became overconfident.
This overconfidence, combined with little experience with bear
markets, left many investors wondering what hit them. The classic mistake
for inexperienced (and even experienced) investors is to watch prices
rise in a bull market and buy near the top. Then when the market heads
south, they follow the stock down and sell near the low. A “buy high and
sell low” strategy is no strategy at all.
Many folks writing about bear markets encourage investors to sit
tight and ride out the storm. This may make sense if the investor is 30
years from retiring, but the poor soul we mentioned earlier doesn’t have
the luxury of riding out a bear market—she can’t wait five years to recover
her loss. The only way she can meet her immediate needs is to cut
her losses as quickly as possible and retreat to safer investments, such as
cash and bonds.
The lesson of the modern bear markets is that what goes up can and
almost certainly will come down. Investors need to be prepared.
SLAYING BEAR MYTHS
Not all bear markets are the same. However, it is important to slay some
basic bear myths before we go any further;
■ Everyone loses in a bear market. We’ve defined a bear market as
including most of the market leaders, such as the bellwether S&P
500. Not every stock or even every stock sector loses money during
a bear market, and there are always stocks that do poorly during
bull markets. The cliché that a “rising tide lifts all boats” is not
true in the stock market.
■ You can see it coming. You can’t. Bear markets are notorious for
disguising themselves. Market corrections, which we discussed earlier,
are great decoys for bear markets: You never know when a market
correction is going to escalate into a full bear market. In our
earlier example of 1987, investors faced a sharp market decline.
Was it a market correction that would rebound shortly, or the beginning
of a continual decline into a bear market?
■ Bear traps are false signals sent by the market that suggest it isabout
to reverse course and head up. A bear trap occurs when a
stock drops sharply and panicked investors sell near the bottom,
only to watch the stock rebound. The broad market can execute
bear traps also. A straight-line drop in prices seldom marks a bear
market. Most often, prices will fall, then rebound to a level near
the original point, and repeat the pattern over and over. However,
the long-term trend is that the rebound never quite regains all the
lost ground.
Casinos use a version of the bear trap on their slot machines.
You put in three coins and pull the lever. A ringing sound means
you won. However, when you look in the tray, the machine has
only returned two coins. This incremental loss doesn’t seem as bad
as not getting anything back, so you’re encouraged to try again. In
the stock market, this type of incremental decline is a perfect disguise
for a bear market.
■ Bear markets can be averted. It’s preposterous to think we can
control the stock market. If we could control the stock market,
there would never be any bear markets. Actions can encourage or
discourage bear markets (such as interest rates and taxes), but there
are no controls. In Chapter 3, we’ll discuss the causes of bear markets
in more detail. We may even need bear markets to bring down
stock valuations to more reasonable levels, thus setting up future
bull markets.
The Persian Gulf War caused the bear market that began in
1990. Oil prices escalated along with interest rates. Rising energy
prices often lead to inflation. All these factors negatively affect the
stock market. Toward the end of the 1990s bull market, the Federal
Reserve Board (the Fed) raised interest rates six times and oil
prices escalated. Many feel the Fed went overboard in its attempt
to cool the economy and precipitated the bear market.
■ The Fed is responsible for the stock market. The Fed is not responsible
for the stock market, although it watches the market
closely. Fed pronouncements about the economy and interest rates
are widely followed by investors. The Fed views its primary responsibility
as controlling inflation. Inflation is a primary cause of bear markets, but the Fed is more
concerned with the whole economy. Inflation is deadly to any
economy and benefits virtually no sector. The Fed of course knows
that raising interest rates could eventually hurt the stock market,
but inflation hurts everyone.
Read More : A BEAR LESSON
