As an investor, it’s natural to feel uncertain from time to time. This is especially true when markets are reacting sharply to changing economic conditions. During periods of crisis, it can be helpful to reflect on the past as a means to help frame the eventual path forward.
Setting the stage
In the world of investing, the terms bear market and bull market are frequently cited. However, there is some debate over the precise definition of each term.
- Bear market: occurs when an index or asset drops 20% or more, encompassing the period of time from market peak to market trough.
- Bull market: can be thought of as all periods between the bears, from market trough to market peak.
We’ve been here before
Despite the uneasy feelings associated with any pullback in financial markets, it can be reassuring to know that these are not uncharted waters. In fact, if you look at U.S. equity markets spanning the past 66 years, there were 10 distinct bear market events. This suggests that on average, long-term investors have encountered a bear market roughly once every seven years.
A history of U.S equity of bull & bear markets
- Bear markets come in all shapes and sizes. Some bear markets are mild and quick, like the one in 1957 where U.S. equities fell 20.7% and then began to recover in about 3 months. Other bears have been quite severe. For instance, during the global financial crisis, U.S. equities fell nearly 57% during a bear market that lasted roughly a year and a half.
- Long-term resiliency of markets. Regardless of the severity or length of the pullback, markets have always recovered along the path to achieving new highs over the long term.
- Lower asset prices should lead to higher long-term returns. Trying to time the bottom of a bear market is next to impossible. That said, regardless of when people invest during a bear market, history suggests they usually see positive subsequent returns over the long term.
The chart below shows that each time the market has dropped by a significant amount, the bounce back in the following year has also been significant. This pattern has repeated across bear markets since 1950.
Watching the value of your investments fluctuate can be an emotional experience. Yet, while it may not feel like it in the moment, bear markets are a normal part of the long-term investment cycle. During these times, making dramatic changes to your investment portfolio may feel like a natural reaction. However, this can have a serious impact on your ability to reach your long-term goals.
It’s not easy to balance what you read in the headline risks with your knowledge of the improved long-term return potential. However, doing so in the context of a carefully considered financial plan greatly improves the odds of investment success. In fact, it may even help you view periods of market weakness as an opportunity to buy investments on sale.
It's important to stick to your financial plan - and that means managing portfolio drift when markets move. Your advisor can help.