What Is A Bear Market, And How Can Investors Make The Best Of Lower Prices?

A bull market occurs while the stock market is gaining value. A bear market happens while the market's value drops.

You can make money from a bull market or a bear market. The key to success often lies in your discipline and focus as an investor, not in the market's jumps and dips.

Nevertheless, it can be scary when you see a big red arrow pointing down on the financial news networks. But market corrections, even sharp drops, are inevitable. If you're going to invest in anything, you likely want to be prepared for a downturn.

So let's dive deep into what a bear market is, whether or not we're in one, and how you might use current economic conditions to improve your financial standing. 

Investing 101: What is a Bear Market

A bear market happens when the stock market experiences a prolonged period of decline, typically defined as a drop of 20% or more from its most recent peak. Bear markets can result from a specific point, such as the DotCom bust of 2000 or more recently, the COVID-19 pandemic of 2020. 

In June 2022, the U.S. stock market entered bear market territory. 

How should investors respond to a bear market?

While it can be tempting to sell everything and cash out, most savvy investors know that this behavior rarely produces wealth. That's because bear markets have historically always been followed by bull markets, which is when prices start to rise continuously. 

If you’re consistently selling during a bear market and buying during a bull, you are guaranteed to lose money. 

So, if you can stomach the volatility and have some extra cash on hand, investing in a bear market can lead to big rewards down the road. In fact, many millionaires amassed their wealth during periods of economic turmoil. They invested early and held on tight until the good times returned. 

As Warren Buffett famously said: Be fearful when others are greedy, and greedy when others are fearful.

How Lower Prices Can Position You for Long-term Growth

One way you might take advantage of a bear market's lower prices is to invest in stocks or market segments (asset classes) that have been beaten down but that have long-term growth factors. Some factors you might consider include strong fundamentals, company size, geography, relative price, and expected profitability. Another way is to invest in companies that are experiencing temporary problems. These companies may be undergoing financial difficulties or poor management, but you believe they still have the potential to rebound. 

Finally, investors may take advantage of lower prices by investing in companies that are undervalued by the market. These businesses may be new, or they may fit into the above, but they all have one thing in common the potential for long-term growth. .  If you are investing new cash or rebalancing your existing investments, any of these strategies may allow you to put your money in the market and benefit from the market upswing.

By taking advantage of lower prices, investors can position themselves for long-term growth. 

Historically, What Asset Classes Perform Well in a Bear Market?

Should you invest like usual during a bear market, or should you change your strategy and put your money in a different asset class?

As always, you shouldn't do anything without considering its impact on your overall investment strategy or talking it through with your financial advisor. In general, however, asset classes can respond differently to market downturns, so if you are highly risk adverse, it may be wise to make changes to your investment plan.

Let's take a look at four major asset classes and how a bear market may affect them:

Bonds

When the stock market falls, bonds are the only asset class that have continually outperformed expectations. In part, this is because when investors sell stocks, they usually look to buy bonds. Which is often considered a “safer” investment. Consequently, bond prices go up or tend to outperform stocks during times of turmoil. As a result, bonds can provide a safe haven for investors during a bear market. In 2008, US intermediate bonds provided an annual return of 5.8 percent, even as stocks were down by 37 percent. 

Bonds are a conservative measure to protect your portfolio from downside risk, however. Over the 15-year period ending on 12/31/2021, intermediate bonds provided an overall annual return of 3.5 percent while US stocks provided an average annual return of 10.7 percent, despite fluctuations.  Bonds generally provide a lower rate of return compared to stocks — even when you account for bear markets. The price of the bond, and the interest you receive on a bond, may fluctuate with changes in interest rates. So if rates rise, you could see the price of your bond fall as investors prefer to buy newly issued bonds paying the higher rate.. Bonds can also provide liquidity and capital preservation when needed most, making them an ideal investment to have when markets are turbulent.

Generally, the closer you are to needing your money, or the more risk-averse the investor, the more likely they are to put money into bonds.

Gold, Silver, and Other Commodities

Traditionally, investors retreated to gold as a safe haven during hard times.  

In periods of economic turmoil, such as the recent recession in 2008-2009, some investors sold their stocks and bought commodities such as gold and silver because they believed these assets would not lose value due to inflation. It’s important for investors to remain cautious, however. Let’s looks at an example:  Gold, in particular, is seen as less volatile than other investments like stocks or bonds because it does not depend on what publicly traded companies are doing or what policies the government is enacting. However, looking at longterm benchmarks, gold actually tends to be more volatile than most US stocks. 

All that glitters, however, is not a safe investment.

After the U.S. abandoned the gold standard for its currency in 1971, gold became less of a haven. Over the past 30 years, the DJIA (stock market) has grown by about 807% while gold has risen just 385%. Silver and other precious metals feature a similar track record. As you can see, commodities don’t always equal a  strong long-term investment.

Cash

Some investors run to cash in a bear market because cash won’t lose its value (except through inflation) and is FDIC insured up to $250,000 per person per bank. This makes it a safe investment for emergency funds, short-term goal funding, and during times of market turmoil. However, keep in mind that countries can devalue their currency by increasing its supply, which leads to inflation. 

Currently, the average interest rate for savings accounts is 0.11% and U.S. inflation is rising at a rate of 9.1% — the fastest growth since 1981 — making your cash less valuable every day. If you sit on your money and wait out this bear market, you may have less purchasing power when you decide to get back in the game. 

Stocks

During a bear market, all stocks generally fall, but not necessarily by the same amounts. More speculative stocks tend to drop further during times of uncertainty. In some cases, a particular segment (or asset class) may experience steeper declines. For example, during 1973 (which was the start of the second longest bear market in U.S. history), U.S. small-cap stocks fell more than U.S. large-cap stocks. But investors may be able to make the best of these lower prices. 

One way is to be patient and wait for attractive buying opportunities. Another way is to take advantage of dividend reinvestments or stock buybacks that can offer shareholders higher yields in a low interest rate environment. Yet another strategy is to invest in an exchange-traded fund (ETF) that invests in a broad portfolio of growth, small, and/or value stocks. Such funds may help you gain broad exposure to a riskier asset class while helping you manage or reduce risk. 

Whatever you choose to do, remember to invest based on your personal time horizon (the period of time you have until you need this money). If you have long-term goals, then you may want to invest more in stocks. If you have short-term goals, then it might be better to focus on more conservative investments such as bonds. .

Think in Terms of Your Total Portfolio

At Cooke Wealth Management, we tell our clients, Think in terms of their overall portfolio strategy.; what is it you’re looking to accomplish?  

Consider it this way: each asset class plays a role within your overall portfolio, all working together to help you accomplish your retirement or investment goals. Designed to provide a desired amount of risk and return. . If you’re looking at changing your investment strategy, remember that it will likely alter the amount of risk and the potential return of your investment portfolio. 

Let’s say you have 70% of your portfolio in equities (stocks) with a medium-risk level. If you decide to reduce that amount to 60%, and move the remainder into cash, then overall you are reducing your equity exposure by 10%. Doing so reduces your risk, but also alters the potential long-term return. Or, if you're thinking this is a short-term solution then you must ask the question - when will you move back?

Timing the Market is Futile

Many investors believe they can time the market, but this is often a fruitless endeavor. Regardless of how the market’s doing overall, the worst trading days and the best tend to take place close to each other. Timing when these days will happen is nearly impossible. They aren’t always expected, and current trends don’t necessarily predict what’s to come. In the last 20 years, roughly 45% of the best 20 days happened in years when the market was down. 

If you try to time the market, you are just as likely to buy at the top as you are to buy at the bottom. In that same vein, trying to pick which stock or segment of the markets will do the best in the near future can be equally as tough. It’s often best to focus on a long-term well-diversified portfolio that can outlast any market swing.

Given the difficulty of timing the market, numerous studies have found that investing excess cash in a lump sum provided an equivalent if not better outcome than those who invested smaller amounts over time. However, some may not have this opportunity and it can be hard to stomach making a $100k investment when the market is down.  Many effective investors use a strategy known as dollar-cost-averaging, which is the practice of regularly investing a fixed dollar amount regardless of share prices. If you’re investing in your employer’s 401k plan each pay period you’re likely already doing this. Dollar-cost-averaging during a bear market can help improve an investor's cost basis and give them the opportunity to capitalize on low prices.

What Can You Do When Volatility Hits?

In a bear market, prices fall, and it can be tempting to sell in order to avoid further losses. However, this isn't generally the best course of action. Instead, focus on things that you can control, like your asset allocation and personal expenses. This will help you weather the economic storm and may help you come out ahead in the long run.  

If you're feeling nervous about where the markets are heading, don't panic; instead, make sure that you have enough cash reserves to cover living expenses for an extended period of time. And stick with a proven strategy. Remember, investing is about minimizing risk while maximizing returns. No one other than God ever knows with 100% certainty what direction the markets will go next. So stay diversified, rebalance your portfolio when needed, and maintain a healthy emergency fund. 

If you would like to discuss your financial strategy during the current bear market, set up a complimentary discovery meeting with one of our wealth management professionals. We'd love to talk with you.