USA TODAY International Edition
How bear markets hurt investors
Nothing strikes fear in investors quite like a bear market.
These perilous periods occur when stock prices plunge, erasing 20% or more of the market’s value, leaving investors to wonder how low stocks will go and how much money they’ll lose. Portfolios hemorrhage during these downturns, which on average last about two years. The average decline in the Standard & Poor’s 500 index in the 13 bear markets since 1929 is 40%, S& P Dow Jones Indices says.
The best time to prepare for a bear is when a bull has run for many years and the market is near recent record highs — like now. The current bull turns 8 on Thursday, with the S& P 500 index having soared 254% since its last extended fall ended March 9, 2009.
No advance lasts forever, and it’s instructive to know what causes serious market drops:
Recessions. The stock market typically runs into trouble when investors see signs of an economic contraction, says Jonathan Golub, chief U. S. market strategist at RBC Capital Markets. Seven of the past eight bulls were ended by the start of a recession, RBC data show.
Recessions follow periods of strong growth that cause the economy to overheat, prices to spike and the value of stocks and homes to inflate. The Federal Reserve can try to cool things down by raising interest rates, which increases borrowing costs for mortgages, car loans, credit cards and company debt. Growth slows and, more often than not, the economy rolls over, taking the market with it, Golub says. “A recession,” he explains, “feels like a convulsion. It’s not like catching a cold. It’s more like pneumonia.”
S& P 500 earnings typically fall 30% to 40% in recessions. Unemployment spikes. Market psychology shifts from optimism to pessimism. The result? People that feel they have to get out of the market start selling.
Financial crises. Banking crises, like the one in 2008- 09, also cause acute market disruptions. Lehman Brothers’ bankruptcy, bailouts of well- known banks and fears that local branches would run out of cash caused a panic. There are no signs of a similar crisis today, Golub says. Banks are in far better shape, with ample cash reserves and a stronger customer base, thanks to private employers adding 16 million jobs the past seven years, according to the Center on Budget and Policy Priorities. Wages rose 2.3% in 2016, the Bureau of Labor Statistics says, enabling workers to keep up with loan payments. Real estate is also stable.
Signs of excess. Such signals include expensive market valuations, or when stock prices relative to corporate earnings rise well above the historical norm. Signs of irrational exuberance include amateur investors diving into the market in search of profit and then bragging about making lots of money. Such euphoria overcame investors in the late 1990s, during the dot- com boom. High levels of optimism and expensive stocks also existed before the 1987 crash.
“Valuations matter,” says Michael Arone, chief investment strategist for the U. S. Intermediary Business Group at State Street Global Advisors. “That fundamental fact has been proven time and again, painfully so in 1929, 1987 and 2000.”