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Bear Markets: This Time is Different (Every Time) - YouTube
Channel: Ben Felix
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- Bear markets are generally defined
[2]
as a peak to trough
decline of at least 20%
[5]
in the stock market.
[7]
Bear markets are not fun to live through,
[9]
but they should be
expected from time to time.
[12]
Every now and then
uncertainty about the future
[15]
drives asset prices down,
[17]
and it usually feels like
things are going to get worse
[20]
before they get better.
[21]
The U.S. stock market
has had 27 bear markets
[24]
from 1900 through March 2020 by my count.
[28]
That works out to a bear market
[29]
every four and a half years on average.
[32]
Even for the most seasoned investor,
[34]
every bear market is equally unnerving.
[37]
Uncertainty is hard for us humans.
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I'm Ben Felix, Portfolio
Manager at PWL Capital.
[43]
In this episode of Common Sense Investing,
[45]
I'm going to tell you why
every bear market is different
[48]
and why that is not a reason
[50]
to abandon a properly
diversified portfolio.
[53]
(bright music)
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Investing in stocks is risky.
[58]
Risk is not a flaw in the stock market,
[61]
it is for taking on the
risk of owning shares
[64]
in businesses that investors are able
[66]
to expect positive long term returns.
[69]
Investing in less risky assets
like bonds is also an option,
[73]
but the expected returns are lower.
[76]
This risk-expected return trade off
[78]
is pervasive in investing.
[80]
From 1900 through 2019,
global stocks delivered
[84]
a 5.2% annualized
inflation adjusted return,
[88]
while global bonds delivered
much more modest 2%
[92]
over the same time period.
[94]
That 3.2% annualized difference
might not seem like much,
[98]
but over 30 years at those rates,
[100]
a stock portfolio would
increase its purchasing power
[103]
2.5 times more than a bond portfolio.
[106]
Who wouldn't go for that?
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Lots of people.
[109]
And I'll tell you why.
[110]
The challenge with investing
in risky assets like stocks
[114]
is that despite their
positive expected returns,
[117]
they tend to be volatile
in the short term.
[120]
This can make sticking with a
long term investment strategy
[123]
hard to do.
[124]
Richard Thaler and Shlomo
Benartzi referred to this problem
[127]
as myopic loss aversion in
a 1993 paper aptly titled,
[132]
Myopic Loss Aversion and
the Equity Premium Puzzle.
[135]
They theorized that
investors are loss averse,
[139]
meaning they're distinctly more sensitive
[141]
to losses than to gains,
[143]
and that they evaluate
their portfolios frequently,
[146]
even if they have long
term investment goals
[148]
such as saving for retirement.
[150]
Myopic loss aversion might
be easier to live with
[153]
if we always knew how the story would end.
[155]
Enduring losses with the knowledge
[157]
that things will be better soon,
[159]
is a lot easier than
living with the uncertainty
[162]
of a specific situation.
[164]
I can't tell you how
the current bear market
[166]
or future bear markets will end.
[169]
Uncertainty is tricky like that.
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But I can tell you how
things have played out
[173]
after past bear markets and
how uncertain things seemed
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for investors at the time.
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I'm using monthly U.S. stock market data
[181]
because Robert Shiller publishes it
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on his website going back to 1871,
[184]
and you can download it there too.
[187]
Since 1900, the U.S.
has had 27 bear markets.
[190]
On average the decline has
been 30% from peak to trough,
[194]
and it has taken 13 months
for that drop to happen.
[197]
From the bottom, it has taken on average,
[200]
27 months to return to the previous peak.
[203]
I think it's easy to see
those data and think,
[205]
hey, that's not so bad.
[207]
I can handle a 30% drop over 13 months
[209]
and a 27 month recovery.
[211]
If only it were that easy.
[213]
When a market drop is happening,
[215]
you don't get to see where the bottom is.
[218]
And in most cases, there's
a lot of reason to believe
[221]
that things will not get better.
[223]
Here's some past bear
markets with what I think
[226]
are particularly unnerving causes.
[228]
During the Panic of 1907,
[231]
the U.S. stock market
dropped 36% over 14 months.
[235]
Preceding the drop, the
U.S. had been devastated
[237]
by the San Francisco
earthquake and fire of 1906.
[241]
The economic fallout of the earthquake
[243]
pushed the U.S. economy into
a recession in May 1907.
[247]
And soon after that the
financial sector crashed.
[250]
Banks collapsed, including the
Knickerbocker Trust Company,
[253]
which was one of the
largest banking institutions
[255]
at the time.
[256]
A massive natural disaster,
macro economic troubles
[259]
and a domestic financial crisis,
[262]
that doesn't sound like a good time.
[264]
It's easy to look back now and see
[266]
that the market bottomed
out by October 1907
[269]
and recovered by July 1909.
[271]
But without having that knowledge,
[273]
enduring the drop would
have been challenging.
[275]
Moving ahead a few years,
the New York Stock Exchange
[278]
had closed for an unprecedented
four months in 1914
[282]
to avoid a financial
crisis due to the war.
[285]
Talk about uncertain times.
[287]
After the reopening of the exchange,
[289]
the U.S. market rose to a
new peak in October 1916.
[293]
In late 1917, a nasty flu
now known as the Spanish flu,
[298]
was sweeping through U.S. military camps.
[301]
The virus rapidly spread across the globe,
[303]
probably through the
movement of troops during
[305]
and after World War I.
[306]
Around the same time as the
first reported cases of the flu,
[310]
the U.S. stock market took a steep dive,
[312]
dropping a little more than 30%
[314]
from the October 1916 peak to
the trough in November 1917.
[319]
If we account for inflation,
[321]
which was quite high at the time,
[322]
that drop in real terms was closer to 45%.
[326]
The 1918 flu pandemic had a
huge economic impact globally,
[330]
reducing GDP by an estimated
six to 8% in a typical country,
[334]
as interventions similar
to those that we are seeing
[337]
today were put in place,
restricting economic activity.
[340]
It seems likely that the combination
[342]
of public health concerns
and economic uncertainty
[345]
made this a challenging
time to stay invested.
[348]
Nobody knew when the bottom would come.
[351]
An interesting point here
[352]
is that while the worst of
the Spanish Flu did not come
[354]
until later in 1918, the
market had already started
[358]
its recovery by then.
[359]
The theoretical explanation for
this might be that the worst
[362]
of the pandemic had already been priced
[364]
into the market in 1917.
[367]
Of course, nobody would
have known that at the time.
[369]
Fast forward to 1929,
after nearly a decade
[372]
of leveraged speculative
investors driving up stock prices,
[376]
the stock market reached
a peak in September 1929,
[379]
plummeted in October and
was down 30% by November.
[383]
It continued to fall until June 1932,
[387]
when it reached a peak
to trough decline of 83%.
[391]
During this massive decline in prices,
[393]
there was also a severe drought
[395]
that impacted the U.S.
agricultural output,
[397]
significant deflation
which discouraged spending
[400]
and global tariffs reducing trade.
[403]
U.S. unemployment reached 25%
[406]
and thousands of U.S.
banks failed in the 1930s.
[410]
If economic hardship weren't enough,
[412]
Americans were watching as
communism and fascism took hold
[415]
in other parts of the world,
[417]
no doubt raising concerns
about the viability
[419]
of the American way of life.
[421]
The bottom came in June 1932,
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33 months after the September 1929 peak,
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but it wasn't a smooth ride back up.
[429]
If you had invested at the
peak in September 1929,
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you would have not recovered
your initial investment
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in nominal terms until
June 1944, 15 years later.
[440]
Between 1932 and 1944, there
were four other bear markets
[444]
with peak to trough declines
of 30% in February 1933,
[448]
20% in October 1933, 20% in
July 1934 and 50% in March 1938.
[455]
The 30s were not a fun
time to invest in stocks.
[458]
I think it's worth mentioning
[459]
that it took 15 years to recover
[461]
from the 1929 stock market
crash in nominal terms.
[465]
But this was a significantly
deflationary period,
[468]
the price of goods was falling.
[470]
If we adjust for deflation,
[472]
the recovery came much more quickly,
[474]
in about seven years from
the peak in September 1929.
[477]
A little over four years
from the bottom in June 1932.
[481]
That's still a long time to recover,
[482]
but not nearly as daunting as 15 years.
[485]
The 1930s were particularly turbulent,
[487]
but we don't have to go far into the 1940s
[490]
to find our next bear market.
[491]
The market dropped 28% from
its peak in September 1939
[495]
to its trough in April 1942.
[498]
This decline was punctuated
by Hitler's invasion
[500]
of Western Europe in May
1940 and the Japanese attack
[504]
on Pearl Harbor in December 1941.
[507]
That's the kind of uncertainty
that makes your head spin.
[509]
At least it makes mine spin.
[511]
I can't even imagine
living, let alone investing
[513]
through that type of uncertainty.
[516]
Only nine months after the bottom,
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the market was back up
to its previous peak.
[520]
In September 1974, stocks fell 46%
[524]
from their December 1972 peak.
[527]
The U.S. economy had entered
a recession in November 1973
[531]
and inflation was surging at the time.
[533]
That 46% drop in the stock
market was closer to a 60% drop,
[538]
adjusted for inflation.
[540]
President Richard Nixon had
taken historic economic measures
[543]
to combat inflation in 1971,
[545]
commonly referred to as the Nixon shock,
[548]
but they ended up failing.
[549]
Adding to inflationary pressures in 1973,
[553]
the Arab-Israeli war broke out,
[554]
resulting in the 1973 oil crisis.
[558]
By March 1974, the price of
oil had risen nearly 400%.
[563]
27 months later, in December 1976,
[566]
the market returned to its 1972 peak.
[569]
More recently, we have had the tech bubble
[572]
with a peak in March 2000 and
a trough in September 2002,
[576]
with a 45% peak to trough drop.
[579]
Maybe less intimidating in terms
[580]
of the associated uncertainty,
[582]
but at the very least the hopes and dreams
[584]
of temporarily wealthy
technology investors were shaken.
[588]
The U.S. ended a recession in March 2001,
[590]
which lasted a year.
[592]
The recovery in the stock
market took four years
[594]
from the September 2002 trough.
[596]
The great financial crisis
started in October 2007,
[600]
with the stock market reaching
a trough in February 2009,
[603]
down over 50% from its peak.
[606]
Loose lending and outright fraud
[608]
in the subprime mortgage market
[609]
had resulted in a
precarious housing bubble
[612]
and a baking and liquidity crisis.
[614]
The crisis nearly resulted in the collapse
[617]
of the global financial system
[618]
and all of the civil unrest
that could have come with that.
[621]
And it did result in the collapse of large
[623]
and historic U.S. institutions
like Lehman Brothers.
[627]
Three years after the
trough in February 2012,
[630]
the market was back to
its October 2007 peak.
[634]
Alright, alright.
[635]
But the U.S. has had
tremendous economic success.
[638]
I know that.
[639]
Maybe it isn't fair to
cherry pick their data
[642]
to instill optimism in the stock market.
[645]
What about the elephant
in the room, Japan.
[648]
Today, Japan is a third
largest economy in the world.
[652]
In the 1980s, Japan was
an economic powerhouse,
[655]
and its stock market was
the largest in the world,
[658]
making up 45% of the world's
[660]
public equity market capitalization
[663]
by the start of the 1990s.
[665]
The USA made up 29% of the
global market at that time.
[669]
The MSCI Japan index
delivered an annualized return
[672]
of 22.4% from January 1970
through December 1989,
[679]
nearly double the return
of the U.S. stock market
[681]
over the same time period.
[683]
Starting in early 1990, the
Japanese economy began to stall,
[687]
and its stock market dropped
36% by the end of the year.
[691]
But here's the interesting part,
[692]
it never really came back to life.
[695]
From January 1990 through December 2019,
[698]
Japanese stocks have
delivered an annualized
[701]
0.6% return before inflation.
[705]
At the time of the collapse,
Japan had low interest rates,
[708]
high stock market and
real estate valuations
[711]
and a heavy corporate debt load.
[713]
If that rings a bell, it should.
[715]
All of those characteristics could be used
[717]
to describe developed
countries like Canada
[719]
and the United States today.
[721]
To combat their slowing economy
and falling asset prices,
[725]
Japan used some of the
economic policy initiatives
[728]
that we are seeing today,
like quantitative easing
[730]
including the purchase of corporate bonds
[733]
and extremely low policy interest rates.
[735]
Comparing any situation
to 1989 Japan is scary.
[739]
Japan had a market drop 30 years ago
[742]
that it has not recovered from today.
[745]
It's easy for the representativeness
heuristic to kick in,
[748]
estimating the probability of an outcome
[750]
based on the outcome of a similar event.
[753]
If the developed world today
it looks like Japan in 1989,
[756]
maybe this time really is
different like it was for Japan.
[760]
When Kahneman and Tversky first described
[762]
the representativeness
heuristic in their 1974 article,
[766]
Judgment Under Uncertainty,
Heuristics and Biases,
[769]
they explained that this
approach to the judgment
[771]
of probability leads to serious errors,
[774]
because similarity or representativeness
[776]
is not influenced by several factors
[779]
that should affect
judgments of probability.
[782]
Put simply, assuming
that the Japanese outcome
[784]
will be repeated based
on some similarities
[787]
probably doesn't make sense,
[789]
especially considering that stock market
[791]
and economic forecasts are often wrong.
[794]
I don't think that the Japan story
[796]
is an argument against optimism,
[798]
it is instead an argument
in favor of diversification.
[802]
And I don't just mean
geographic diversification.
[805]
Over the same period that
the Japanese stock market
[807]
returned 0.6% per year,
[810]
Japanese small cap value
stocks returned 5.13% per year,
[814]
and Japanese market wide
value stocks returned
[817]
4.04% per year.
[820]
I'm not saying that those
are impressive returns,
[822]
but even over this period
where the Japanese market
[825]
was flat for decades,
value stocks delivered
[828]
an independent source of return.
[830]
This outcome is consistent
with economic theory.
[834]
The same thing happened
in the U.S. for the decade
[836]
from March 2000 through February 2010.
[839]
You lost money in the U.S. stock market
[841]
as a whole for a decade,
while U.S. small cap value
[845]
and market wide value stocks
delivered annualized returns
[848]
of 7.94% and 4.56% respectively.
[852]
You can't make this stuff up.
[854]
Global capitalism has been a
triumph of human resilience,
[857]
perseverance and dynamism.
[859]
That doesn't mean that
things won't change,
[862]
like Japan being the largest stock market
[864]
in the world in 1989 or the
UK being the largest in 1899.
[869]
Some markets will decline permanently
[871]
or at least for extended periods of time,
[873]
as well some industries and
lots of individual companies.
[877]
That is not an argument
to get out of stocks
[880]
when the market inevitably drops.
[882]
Every bear market is different.
[885]
Bear markets happen due to uncertainty
[887]
and uncertainty is
understandably hard to process.
[891]
Nobody can see where the
bottom of a bear market is.
[894]
Historically, most bear markets
[896]
have been followed by recoveries,
[898]
rewarding those investors
who stuck to their strategy.
[902]
It is true that some bear
markets have not recovered,
[906]
but for a properly diversified investor,
[908]
hanging on through periods of uncertainty
[910]
has produced a reliably
positive long term outcome.
[914]
Thanks for watching.
[915]
I'm Ben Felix of PWL Capital
[917]
and this is Common Sense Investing.
[919]
If you enjoyed this video,
[920]
please share it with someone
who you think could benefit
[922]
from the information.
[923]
And don't forget, if you've run out
[925]
of Common Sense Investing videos to watch,
[927]
you can tune in to weekly episodes
[928]
of the Rational Reminder podcast
[930]
wherever you get your podcasts
[932]
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