Bear markets can be shorter than you think
Bear markets are painful, but don't last as many years as some investors might fear
Investors in or approaching retirement are among those who have the most to lose in a bear market. Their investment horizons might not be long enough to recover from the losses.
But how long must your horizon be to have a rational expectation of recovering from a bear market? The answer might surprise you: The typical recovery time is relatively short, in terms of years.
Of course, we don't know for sure whether we currently are in a bear market, defined as a drop of at least 20% from a recent peak. Though earlier this year some smaller-cap indexes such as the Russell 2000 satisfied that criterion, the broader market averages so far haven't. For example, at its low point earlier this year, the S&P 500 was 14% below its all-time high set in May 2015.
But even if you do think we're in what will one day turn out to be a bear market (meaning we drop 20% from that May peak, which becomes the start of the bear market), consider this: On average, it takes just 3.1 years after a bear market begins for stocks to battle back to where they stood before it began. That 3.1-year period encompasses both the initial bear market, which on average lasts almost exactly one year, and the subsequent recovery, which lasts another 2.1 years.
What history says
I calculated these numbers by focusing on the 28 U.S. bear markets since the mid-1920s that appear on a calendar maintained by Ned Davis Research, the institutional research firm. My analysis took into account all publicly traded stocks, as well as inflation and dividends.
What these numbers mean: On the assumption that a bear market began in May and that it and the subsequent recovery will be historically average, stocks will surpass their previous high by June 2018.
That's a little more than just two years away from now. Even retirees in their late 80s have average life expectancies longer than that.
To be sure, this good-news scenario is based on historical averages, and some bear market recoveries take longer. But it's important not to exaggerate the length of even these longest of recoveries.
Consider the recovery from the 1929 crash, which many consider a nightmare scenario: The Dow Jones Industrial Average DJIA, +0.69% didn't surpass its September 1929 peak until November 1954, more than 25 years later.
But the Dow in that case paints a distorted picture, since it reflects just 30 stocks rather than the entire stock market. What's more, it doesn't take dividends into account, which were significant during the Great Depression, when the Dow's dividend yield reached as high as 14%. Nor do the Dow numbers reflect the greater-than-30% deflation that occurred in the 1930s, one consequence of which was that the dollar increased significantly in value.
Properly adjusting for all of these factors, I found that the stock market by March 1937 had battled back to its September 1929 peak. Though that seven-year seven-month recovery time is longer than the historical average, it's a lot better than 25 years.
Solace also comes from the speediness of the recovery from the recession of 2008-09, which many consider to be the worst since the 1930s. By January 2013, the stock market's inflation-and-dividend-adjusted level had risen back to where it stood at its October 2007 peak. That was just over four years after the bear market's bottom in March 2009, and a little more than six years from the market's pre-bear-market level.
The longest recovery time since the mid-1920s was from the 1973-74 bear market: It wasn't until December 1984 that the inflation-and-dividend-adjusted level of the stock market was back to where it stood in January 1973. But a big contributing factor to that lengthy recovery was that era's double-digit inflation, and one could argue that inflation is unlikely in coming years to be as big a headwind for equities.
Holding on
Note carefully that these historical averages assume that you have the intestinal fortitude to hold on to your equity positions throughout a bear market and not dump them. If you do that, all bets are off.
These averages also assume you have invested in a broad market index fund and aren't engaged in the in-and-out trading of specific stocks, either directly yourself or by investing in an actively managed mutual fund. Though some advisers in the past have beaten the indexes doing that, the vast majority — around 80%, in fact — have ended up doing worse.
One of the least expensive ways to invest in the entire stock market is Vanguard Total Stock Market ETF VTI, +0.44% which charges an expense ratio of just 0.05% annually, or $5 per $10,000 invested.
There is no denying that bear markets are painful affairs. Furthermore, because there is no guarantee that the future is going to look like the past, they will tempt you to throw in the towel and dump your stocks. However, if you do that and if history is any guide, odds are overwhelming that you will eventually regret your decision.
Posted by: sarah_oz@yahoo.com
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