‘You might just have to bear with me for a while’
Like you, I don’t know if we’re in a bear market. I’m not talking about a technical bear market here, like the Covid sell-off in 2020, but a proper bear market like 2008 or 2000. They’re very different beasts and it’s useful to understand why.
To officially qualify as a bear, all a market needs to do is drop by 20%, which is what it did in 2020.
But 2020 was a cakewalk compared to 2008 – partly due to worse peak-to-trough losses (26% vs 38%), but more so because they took longer to play out (one month vs 17).
That makes a difference: Being in a dark place for that much longer takes a gruelling psychological toll that’s worse than a short, sharp loss.
Near, far, wherever you are …
If you want to understand how it feels, I’d start by rewatching Titanic. Once the ship has (spoiler alert) struck the iceberg, the moods of the passengers track what investors can expect to endure as they move through a bear market (albeit stretched over two years, not two hours).
To begin with there’s denial: ‘Don’t be ridiculous, this ship can’t sink!’ But as bad things keep happening, denial turns to fear, which becomes panic, and finally capitulation. This is when previously stoic passengers fling themselves into the icy ocean.
Obviously there are differences. In Titanic it was freezing water, but in a true bear market it’s the hope that kills you. Because unlike 2020, real bear markets play cruel psychological tricks.
We don’t need another hero
In 2007, if you were brave enough to buy the initial dip, the quick recovery rally made you feel like a hero (‘Warren, I did it! I was greedy while others were fearful!’). But it was just a bull trap; The rally reversed, and even deeper losses followed.
Those brave enough to try again on the second dip met the same fate; a brief triumph, followed by an even deeper collapse.
Depending on how you classify them, there were seven ‘dips’ in that bear market (see chart). Buying a few, let alone all, of the first false six left you with severe buy-the-dip fatigue. So, by the time lucky number seven finally pitched up, you really didn’t feel like putting your hand on the hot plate again. This is why, months into the next bull market, many investors were still stuck on the sidelines having been conditioned to mistrust a rally.
The proudest fellow in the Easter parade
Managing client expectations also takes a toll. You can give them the ‘this will all be over by Easter’ line, and you might genuinely believe it too. But when Easter comes and Easter goes, and markets are still falling, and then so does Christmas, and so does next Easter, hope gradually turns to despair and your credibility crumbles.
So, it’s time to sell out, right?
Well, that’s up to you, but I’m not.
Why?
Firstly because of my first golden law of market sell-offs (which I’ve borrowed from the world of earthquakes and forest fires):
When a sell-off starts, it doesn’t know how big it’s going to get.
And neither do I. And neither do you. And neither does that smart-sounding strategist who just popped up in your inbox.
Accepting this truth means accepting the market may have already troughed. Maybe what was bugging investors was, say, a lack of action from central banks, and the central banks have just figured this out, and tomorrow they act. This ends the bear market (if it ever became one).
So, if you’ve just sold out, you’ve locked in all the losses and got none of the recovery.
Things can only get better (maybe)
However, it also means accepting that it might get worse, and that it could last years. Maybe whoever needs to solve the problem hasn’t twigged that they need to act, and they won’t do so until a collapsed market forces their hand.
This leads to my second golden law of market sell-offs, this time inspired by the world of medicine (specifically Hickam’s Dictum):
A market can have as many diseases as it damn well pleases.
This – having multiple causes, not just one – is another reason you’ll never know (until well after the event) if a bear market has ended or not.
Let’s all meet up in the year 2000
Take the 2000 edition, which lasted 30 months. This began because markets sniffed an impending recession, which mixed badly with wildly over-valued tech stocks. However, 16 months in we had the tragic horror of the 9-11 terror attacks, and the bear market gained a new lease of gloom due to concerns over military conflict (that bear ended on the day of the Iraq invasion in March 2003).
There are signs of this in our current sell-off. It was initially triggered by Chinese competition challenging American AI dominance (and, for all we know, by markets sniffing out another recession).
However, the nature and severity of the sell-off changed on ‘Liberation Day’. Our value funds, for example, were actually rising during the initial falls, but joined down when Trump dropped his T-bombs. Are these two separate problems? Or shades of the same thing?
He’s making a list, he’s checking it twice
The message, then, is these things are unpredictable, so don’t try to predict them. What can you do instead?
The first thing to do is to prepare, not predict. But I accept that, if you weren’t already prepared, this advice comes too late.
The second thing is to check what you’re holding. Are you confident it can withstand a nasty bear market? Is its quality good enough? Is it at risk of a permanent drop because its price is too high?
On this front I’m confident. My equity portfolio is 100% active, and I know my stock pickers are constantly checking each of the 1,000+ companies in our portfolio against these two risks.
I also know that equity markets survive and grow over the long term and as I can’t time markets, I want to stay exposed to their compounding magic. Having confidence in what I hold is crucial here.
Where I might be worried is if I’d ignored companies’ fundamentals and instead picked stocks because of an exciting story or just because they make up a large part of an index.
You’re feelin’ the change of the guard
I’d also be concerned if I had too much exposure to the winners of the last decade’s megatrend – history shows these have a tough time when the regime changes (which it has roughly once every decade – see Japan in the 90s, mega-cap tech in the 00s, and BRICs in the 10s).
If I’d invested on this basis, and not checked quality and value, I suspect I’d now be incubating a seed of doubt that, in time, may grow into fear, then panic, and finally costly capitulation.
Selling out at the bottom of a bear market leaves you treading water in the iciest of oceans, and it’s this fate that must be avoided.
Simon Evan-Cook is a Citywire A-rated fund of funds manager at Downing Fund Managers where he runs the VT Downing Fox Funds range.
* Data is for the FTSE World Index in sterling terms. Source FE Analytics.
