My Take: This Is Only a Drill

Remember all those fire drills in elementary school? They let us rehearse the thoughts and actions we’d need if and when calm turned to calamity. With markets generally behaving themselves, now is an ideal time for all investors to run a quick bear market drill.

Like fires, floods and tornados, bear markets are scary. Watching security prices fall far and long can feel like watching the end of the world in slow motion. In the moment, bears seem like absolute tragedies, but are they?

There Will Be Bears

If we define a bear market as a 15 percent or greater decline in the S&P 500 Index, we count 14 such events since 1950, or one about every four and a half years. They’re plotted below, with losses ranging from –16 to the harrowing –56 percent of the 2008 financial crisis. The duration of each bear, in days, is indicated by the number below its gray bar.

Bear Markets 1950–2013

Price-only decline of 15 percent or more, with duration indicated in days.

Bear_Markets_1950-2013_031914_for_BA_site-1024x768

Bear markets don’t last forever, but at an average of 365 days, it can seem like they do. That’s plenty long enough to start wondering if things will ever turn around.

It’s also long enough for many investors to give up and to bail out of the market just to stop the bleeding. This is a natural reaction, but like panicking in a fire, it can be very costly. It generally means selling low and buying back in at some higher level.

Fortunately, bears do end, and what happens afterward is fairly remarkable. The graph below shows the same 14 bear markets in gray, this time dwarfed by the dramatic up markets that follow, shown in orange.

Bull and Bear Markets 1950–2013

Bear markets are price-only declines of 15 percent or more.

Bull markets are price-only increases of 15 percent or more.

Bull market durations are indicated in days.

Bull_and_Bear_Markets_1950-2013_031914_for_BA_site-1024x768

Bulls Are Bigger

Bull markets are not only stronger, averaging +103.9 percent versus –29.7 for bears. They also last far longer: 1,217 days.

Since 1950

Average price change

Average duration

(days)

Longest Duration

(days)

Bear markets

–29.7%

365

929

Bull markets

+103.9%

1,217

2,836

It is very easy to forget all these numbers amid the turmoil of a bear market, but for investors committed to long-term goals, bull markets far outweigh the bears. Historically, bull markets have not only erased all the cruel bear market losses, they’ve driven the S&P 500 Index from 16 in January 1950 to 1,848 on December 31, 2013, not to mention all the dividends along the way.

There is no way to predict when the next bear market will start or how long it will last. But it will come sooner or later. It will be unpleasant, it will end and the market will go up again. These are the facts of life for long-term investors.

So here are the three essential steps we want to practice when markets turn sour: Take a deep breath, leave your portfolio alone and go on with life.

This concludes today’s drill.

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