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Is The Bear As Bad As He Appears?

By: Investor Solutions

By: The Financial Planning Association

Over the course of the past year and a half, many investors, for the first time, have shaken hands with the bear, after riding the bull through nearly the entire 1990s. Although the overall market has rebounded somewhat from its recent lows, the bear remains a gloomy presence for many investors. But just how bad is this bear market? How does it compare with other bear markets, and with bull markets? How long do bear markets last?

Before answering these questions, let’s begin by defining a bear market. Definitions vary among investment experts, but typically it’s considered a 20 percent drop in the market (usually the Dow Jones Industrial Average benchmark) over a period of two months or more. S ["Bear Markets" booklet, Vanguard-file] maller drops, or sharper drops that are very short, are commonly viewed as “corrections.” Some calls are close. The gut-wrenching plunge of the Dow in October 1987 is usually called a bear market, though the decline of 36.1 percent, which actually began in August 1987, lasted slightly less than two months.

Many investors new to the markets during the 1990s may not realize it, but bear markets are a rather common phenomenon. In fact, there have been 14 of them in the last half century, occurring roughly every 3.5 years. According to figures from Crandall Pierce & Company, these declines in the Dow have [my owncalculation from the "Bull and Bear Markets" sheet, file] lasted an average of 12 months and suffered a median decline (half more, half less) of just under 23 percent. [Bull and Bear Markets, file] Of course, averages can be misleading. A bear market in mid-1990, the last one before the long bull market began in October of 1990, hung around a mere 2.8 months. At the other extreme, the 1973-74 bear market lasted a grueling 22.8 months and knocked off 45 percent in stock values.

The current bear market, already over 16 months old, started in mid-January 2000 and had declined 19.9 percent by late March 2001. While it has recovered much of that (down only 6.9 percent as of late May 2001), it won’t officially end until the market recovers to its mid-January 2000 high, according to Crandall Pierce.

During the same half-century, there have been as many bull markets as bear markets. These bull markets averaged twice as long as the bear markets and ran up 65 percent in value on average. The shortest bull market was 11 months, the longest 111 months. The smallest gain was 22.3 percent, the largest was 396 percent. Yet, even these numbers don’t tell the full story about bear markets, let alone their impact on your portfolio. Take the 1973-74 decline, considered the worst since the Great Depression. If you didn’t sell out during the decline, you recovered nearly all you lost on paper by the end of 1976.

Take even a longer view. Consider the [computer file, bear market, p 17]1966 to 1982 stretch. By 1982, the S&P 500 was still 22 percent below its 1966 high. Yet, according to Ibbotson Associates, the S&P 500 returned an annual average of 5.1 percent during those years. That’s below its historical average, but not nearly as bad as many view that period. What accounted for that average? Reinvested dividends, which made up a much larger portion of total return than dividends do today.

Another somewhat misleading aspect of bear markets is that they are usually measured by either the Dow or the S&P 500–both benchmarks for large company stocks. For example, small stocks from 1966 to 1982 returned an annual average (including reinvested dividends) of 12.7 percent. Treasury bills returned seven percent, and international stocks also outperformed U.S. largecap stocks during the same period.

None of this is to say that bear markets aren’t rough on portfolios. The toughest part is coming back from large drops. Say your portfolio loses 45 percent in a 73-74 type bear market. To recover that loss (without investing any more money), you’ll need to earn 81 percent. That’s because you’re working with a smaller amount of money than what you had when the decline started.

The best strategy for recovering from bear markets is to minimize the impact of a market decline in the first place. Review your goals and objectives, stay diversified and don’t panic. Avoid overloading in a single sector (such as technology) and invest for the long term so you don’t have to sell, or sell as much, during a down market.

This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by a local member in good standing of the FPA.