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History & Bear Markets

Click here to buy - A How To Book of SMSF's by Tony Negline
Lester Wills

I recently came across something that may prove useful when talking to people about the current market. As I have said on more than one occasion, bear markets are not actually uncommon, one can even argue they an unavoidable, if unwelcomed, aspect of investing.

Many will be surprised to know that in the US, there have been nine bear markets since 1950, not including the one that began in October 2007. They lasted an average of 13 months but have ranged anywhere from 101 days to more than 600 days.

That begs the question, what actually is a bear market (apart from one that seems to gone down a lot). The common definition is a market decline of 20% in share prices from a previous high point. In the US this is usually measured by the movement in the S&P 500 index (NOT the Dow Jones Industrial Average which is of course only 30 stocks). So, defining what a bear market is actually not difficult, but stating when it stops is another thing because the end of a bear market cannot really be determined until a new bull market has been identified.

This of course begs the question, what is the definition of a bull market. A bull market is commonly defined as a 20% increase in prices from the beginning of the most recent bear market. Notice, that this definition does not use the lowest point reached in the bear slide, but rather refers to the beginning of the bear market.

Whilst bear markets can be painful for investors it is important they maintain perspective. By looking at the characteristics of previous bear markets and the recoveries that followed, it may enable people to not only keep current market conditions in perspective, but to also avoid emotional decision-making that could potentially be very harmful (how many people have fallen into the classic trap of buy high and sell low?).

Sizing Up This Bear

Many will recall my words that investment markets are dynamic. In this regard each bear market seems to have its own personality, stemming from a unique set of root causes. The current slide, beginning in October 2007 may differ from previous ones because of systemic uncertainty caused by a broader credit crisis. The simplistic version of the cause is that the credit markets seized up after some subprime loans that were repackaged and sold to investors began to default. This in turn led the credit markets to dry up, which then imperiled businesses that need to borrow money to finance their operations.

As we all know, it takes money to make money. In the US, this is often borrowed money, something that is probably true in other places but seems especially true in this country. The credit crunch rather disrupted that nexus. When the ability to borrow is limited, it can interfere with a company's earnings, which directly affect its share price.

But of course, things are never simple. Add to this mess its own unique set of circumstances, such as the unprecedented steps taken by the Bush administration to aid the private sector during the credit crisis, the uncertainties created by a closely watched presidential race, and the approaching expiration dates of several favorable tax laws, and it's easy to see that bear markets can be caused, prolonged, or otherwise influenced by a range of real-world events.

Looking Back at Previous Bears

Having said all that, the sensible long term investor expects bear markets as part & parcel of investing and aims to be prepared for them. For the rest it is worth remembering that while it may seem as if the world as we know it is about to end, his whole scenario is actually nothing new. Consider the following about the US market:

* In the nine bear markets since 1950, share prices declined an average of 32%.

* In the 10 bull markets (since June 13, 1949), share prices grew an average of 161%.3.

* Since 1950, the average bear market lasted 400 days.

* However, four bear markets ended in less than one year and five lasted longer than one year. By contrast, the average bull market lasted 1,770 days.

* Only one lasted for less than two years, and seven lasted longer than three years.

* If you had invested $10,000 in a portfolio of stocks mirroring the S&P 500 on January 31, 1950, the portfolio would have grown to more than $6.5 million by December 31, 2007. During this period, the S&P 500 index returned an average of almost 12% per year.

While this period is much longer than the time over which the average investor prepares for retirement, the point is that despite several long and sometimes nasty bull markets, share values have risen significantly over the last 57 years.

Ready for the Bear's Bounce?

Sadly it is not possible to forecast exactly when this bear market will end, but, if history is any guide, share prices will move upward again. It is a question of when, not if.

What many do not realize is that considering this recent bear market began in October 2007, this upward move could be sooner rather than later. Moreover, past performance suggests that investors may eventually benefit from a post-bear bounce that could possibly be significant. In fact, in the first 40 days following a bear-market bottom, the share market has gained an average of 33%.

As difficult as it is to continue investing regularly in shares in the midst of a bear market, as any serious investor knows, there are compelling reasons to do just that. Share prices have historically offered the best chance for returns that will beat inflation over the long term. Furthermore, many successful investors know that when shares are out of favor, it can be a good time to buy. When prices are down, it is possible to accumulate more shares at a lower cost (who mentioned Dollar Cost Averaging?).

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