ULTRA Financial Systems

Bear Markets and Buy/Hold

Bear Market History

A Bear Market is usually defined as a market that loses 15% as measured by a stock market index such as the Standard and Poor's 500 Index (SP500) which consists of the stock prices of 500 U.S. corporations.

Bear Start (1)	Bear End (2)	Bear Length (Years) (3)	Prior Bull Length (Years) (4)	SP500 Loss (5)
Sep29	Jun32	2.8	-	-86.2%
Jul33	Mar35	1.7	1.1	-33.9%
Mar37	Mar38	1.0	2.0	-54.5%
Nov38	Apr42	3.4	0.6	-45.8%
May46	Jun49	3.1	4.1	-29.6%
Jul57	Oct57	0.3	8.1	-20.6%
Dec61	Jun62	0.5	4.2	-28.0%
Feb66	Oct66	0.7	3.7	-22.2%
Oct68	May70	1.6	2.0	-34.0%
Jan73	Oct74	1.8	2.7	-48.2%
Sep76	Mar78	1.5	1.9	-19.4%
Nov80	Aug82	1.8	2.6	-27.1%
Aug87	Dec87	0.3	5.0	-40.4%
Jul90	Oct90	0.3	2.6	-21.1%
Mar00	Oct02	2.6	9.5	-49.1%
Averages	-	1.6	3.6	-37.3%

The table above details all of the Bear Markets in the SP500 since 1929. As you can see from the table:

The average Bear Market decline in the SP500 (Column 5) is 37.3%.
The average length prior Bull Market is 3.6 years. (Column 4)
The average length of a bear market is 1.6 years. (Column 3)

Growth Mutual Funds Will Stay Fully Invested Throughout a Bear Market.

Here's Why:

A Mutual fund's primary concern is keeping your money within the mutual fund family. In order to accomplish this they must outperform the S&P 500 and other mutual funds in bull markets.
The worst possible scenario for them is to miss a major bull market. Investors will simply move their money to other fund families. Therefore, mutual funds will NEVER hold large cash positions. They will be FULLY INVESTED AT THE VERY TOP of every bull market.
As long as the S&P 500 and other mutual funds are going down, they are perfectly comfortable losing your money in a bear market. Their attitude will be that the market will turn and the funds will rebound.
If you are uncomfortable with your bear market loses the mutual fund will recommend that you move your money to a more conservative fund. Thereby, keeping your money within the mutual fund family. And, guaranteeing that you become conservative at the exact worst time, at the bear market bottom just when you SHOULD become aggressive again.
By the way, moving your money from aggressive funds to conservative funds is MARKET TIMING, plain and simple. You can either be very bad at it, (like the example above), or very good at it. It's your choice.

Bear Markets Take All Mutual Funds Down Severely.

A single stock can certainly move contrary to the S&P 500. But, the more stocks in a portfolio, the more likely the portfolio is to replicate the S&P 500 Index. In fact, the Dow Jones Industrial Average, which consists of just 30 stocks, is highly correlated with the S&P 500 Index.
Growth and aggressive growth mutual funds will go down MORE than the S&P 500. These funds invest in highly volatile stocks, which outperform the S&P 500 in both directions. In bull markets they go up more than the S&P 500 and in bear markets they go down more than the S&P 500.
Mutual funds must also absorb overhead such as advisory fees, management fees, and advertising costs. In order to outperform the S&P 500 plus overhead they must invest aggressively. This aggressiveness pays off in roaring bull markets but results in large losses in bear markets.
In an average 35% S&P 500 bear market most growth funds will lose 50% of their value.

The Buy and Hold Timing Method

The Buy-and-Hold strategy is a dream come true for the investment business. Mutual fund companies love it because you give them your money and never take it away or move it. This keeps their costs low and their profits high.

Buy and hold is actually timing. You have to buy at some point and you do have to sell at some point. Without realizing it, buy and holders will use some sort of random timing method to time these purchases and sales.

Buy and hold works historically (in theory).

Historically, the stock market has appreciated at around 10% annually. This is very likely to continue over the long term and here's why:

Americans get better at things.
Generally, a business will grow because the people will find better ways to produce and market products. For years, Microsoft's products were terrible. They just kep improving and the rest is history.
Inflation will push stock prices higher.
I know what you're thinking: high inflation is bad for stocks. True enough. But, think of it this way. If a company was worth $10 million in 1950 with earnings of $1 million annually and had zero real growth until 2001. Its profits would increase equal to inflation and so would its market value. Based on the Consumer Price Index and assuming its Price/Earnings ratio remained 10, the company would be worth $67 million in 1996.

But, buy and hold doesn't work over the long run for most people.

The market can easily move sideways or down for periods of 10 years. Market timers can do very well during sideways periods. Buy-and-holders can lose money for 10 years.
Bear markets are too painful to ride out with significant amounts of capital.
Bear markets are insignificant when you have only $10,000 invested, but what about a hard earned portfolio of $200,000. Every time the market falls 5% you've lost $10,000. After a few months of "market correction" the market is down 30%. You've lost $60,000. The pressure to sell out and save your remaining $140,000 will be very difficult to resist.
Most people give up and sell out very near the bottom. That's what emotions will do for you. It's very easy to say you'll ride out a bear market while the market is soaring, but almost impossible when the market is crashing and all you hear from the media is how the market is going down to zero.

The Main Problem with Buy-and-Hold is Drawdown.

There is a very big problem with the Buy and Hold Strategy that just isn't discussed much, Drawdowns. A drawdown is an "unrealized loss".

For example, assume that at some point your total account value is $50,000. Then the market falls a bit and your account value drops to $45,000. You have just suffered a 10% drawdown. (Drawdown = Loss divided by starting account value.)

Now assume that the stock market skyrockets for a few years and your account grows to $200,000. Then, we get an average bear market of 35%. Your account will lose $70,000.

You won't know where the losses will end. Everyone will be so negative on the future of stocks that the temptation to sell everything will be irresistible. Unfortunately, most investors will sell out very near the bottom and miss most of the ride back up.

This is the problem with Buy and Hold. It's easy to stick with when the market is rising but impossible when the market is falling. If you think you're different and can ride out a bear market you'd better think again about how emotionally painful it will really be.

Note added on 11/12/03:

The above was written before the great Bear Market of 2000. All of the predictions have come true. Investors lost massive amounts of capital. They could not follow their buy/hold strategies and sold out at exactly the wrong time. In order to address the massive amounts of investor losses most investment houses now issue sell signals for the first time in their history (what a concept). However, you still won't find many in the industry that admit that buy/hold is a loser.

Never forget, the investment industry's goal is, and always will be, to keep your money, collect fees and offer little or nothing in return.