If the prevailing economic outlook for the U.S. is accurate, we’re headed for a recession later this year. And, unfortunately for investors everywhere, recessions can be problematic for the stock market. While the S&P 500 has recouped some of its 2022 losses since January, things could go sideways again if economic conditions deteriorate.
Are you prepared for another wave of falling stock prices? Read on through this bear market guide to find out.
Understanding The Bear Market
A bear market is a sustained period of falling stock prices, characterized by a decline in a major stock index of 20% or more. Negative investor sentiment is typically a driving force. That investor pessimism often stems from weakening economic conditions, because they’re usually followed by disappointing earnings results.
Of course, industries and companies respond differently to economic cycles. Consumer staples and utility stocks, for example, can sometimes power through recessions without major earnings declines. Still, that’s not enough to keep stock prices stable. If investors are feeling nervous, stock prices can fall without significant changes in business results.
That’s why bear markets can drive down stock prices of even the most resilient companies. This is one of the more frustrating aspects of a bear market, particularly for novice investors who haven’t experienced it before.
Bear Market Key Stats
There’s no way to avoid a bear market short of staying out of stocks entirely—which isn’t an option if you want to build wealth. The next best strategy is to accept the downcycles and use them to improve your long-term investing returns.
First, let’s tackle the acceptance piece with a few facts:
- Bear markets happen regularly. Since 1928, there have been 27 S&P 500 bear markets, occurring every 3.5 years on average.
- Bear markets are short-lived. The average length of a bear market is less than 10 months. The average bull market, on the other hand, lasts 2.7 years.
- Bear markets aren’t all bad. Some 42% of the S&P 500’s best trading days in the last two decades have happened during bear markets.
At the end of the day, bear markets are part of the investing process. Recognize that fact and turn your focus towards using bear markets to raise your long-term returns.
Why Investing During A Bear Market Can Be A Good Strategy
The basic profit-making formula is to buy an asset and hold it until the value increases. Many investors focus on the second half of that formula, by waiting for their stocks to appreciate. But bear markets create the opportunity to pursue profit-making differently, by lowering your buy price.
At lower prices, you get more shares for your investing dollar. And higher share counts position you for stronger gains as the market recovers. More than one-third (34%) of the strongest trading days in the last two decades have occurred in the transition from bear market to bull market, before it was obvious that a new cycle was beginning.
Here’s an example of how this can play out. Say you decided to invest in SPDR S&P 500 ETF (SPY) in early 2020—when investors were panicking about how the pandemic would affect the global economy.
Between the last week of February 2020 and March 23, 2020, SPY’s price dropped from $311.50 to $218.26. If you’d bought four shares for $300 each, you would have $200 in unrealized gains on that position by September, not including dividends. Today, those four shares would be up about $477, despite the 2022 bear market. That’s an annualized return of roughly 13%.
In short, buying low sets you up for bigger gains in expanding markets. It also reduces your downside risk in future bear markets.
Key Strategies For Investing During A Bear Market
Investing in bear markets isn’t easy emotionally, which is why many investors don’t do it. You must be able to stick to your plan even as your portfolio’s value swings wildly.
Beyond simply toughing it out, there are a few strategies that can ease the stress of investing in troubled markets. The best four of them are explained below.
1. Stay Diversified
You can never fully predict how a bear market will affect a specific company or industry. For that reason, it’s smart to spread your risk across different asset types, industries and companies.
2. Use Dollar Cost Averaging (DCA)
DCA is the practice of investing a set amount regularly, such as $500 monthly. With a dollar-based investing strategy, you buy more shares when stock prices are lower.
Plus, sticking to a monthly or weekly buying schedule averages your cost basis over multiple transactions. This is helpful when stock prices are falling because it pushes your average share cost down. And a lower cost basis means bigger gains later.
3. Buy Defensive, Dividend-Paying Stocks.
Defensive, dividend-paying stocks are more resilient in bear markets. You’ll appreciate that resiliency; it could mean the difference between sticking to your plan and selling out.
4. Reinvest Dividends.
Unless you really need the cash, always reinvest your dividends in a bear market. Reinvesting dividends at lower share prices boosts your share counts quickly. That means higher income and larger gains potential going forward.
With inflation running high at 4.9%, dividend stocks offer one of the best ways to beat inflation and generate a dependable income stream. Download Five Dividend Stocks To Beat Inflation, a special report from Forbes’ dividend expert, John Dobosz.
Dos And Don’ts Of Investing During A Bear Market
Those technical strategies pair well with a few dos and don’ts that’ll help you stay calm during bear markets.
Do Focus On The Long Term
Remember that what’s happening in the market today isn’t terribly important unless you need to liquidate your stocks right now. If you own good companies, they should survive the downturn and recover strongly. Waiting for a recovery often proves to be the most profitable investing strategy in a bear market.
Do Keep Buying If You Have Sufficient Liquidity
From a numbers perspective, it benefits you to invest when stock prices are down. But your personal liquidity is a factor, too. If you’re short on cash and your income is unstable, investing even at low prices may be too risky. You want to avoid the scenario where you have to sell stocks before the recovery sets in.
Do Identify Risk In Your Portfolio.
Make it a point to know the riskiest holdings in your portfolio. Analyze those positions and decide if they’re worth keeping. While it’s not ideal to sell in a downturn, it makes sense to cut your losses if the stock’s long-term outlook has changed for the worse.
Don’t Time The Market
In a perfect world, you’d sell at the top of the market and reinvest at the low point. Unfortunately, even financial experts can’t predict market peaks and troughs consistently. Trying to time the market and failing can leave you on the sidelines when stock prices come roaring back. That could be disastrous for your long-term returns.
Avoid that outcome by practicing dollar cost averaging instead of market timing. Investing consistently allows you to realize incremental benefits from falling share prices.
Don’t Watch Too Closely
If the financial headlines make you nervous, tune them out. Verify your companies are fundamentally solid, automate your monthly investments and leave your portfolio alone. You don’t need to micromanage. Direct your energy towards waiting for the recovery instead.
Case Studies Of Successful Bear Market Investments
As you’ll see below, bear markets can feel disastrous in the moment but look very different in hindsight.
1. Microsoft
One of the more significant bear markets in history was the technology downturn in the early-2000s. The tech-focused Nasdaq index began to slide in February 2000 and wouldn’t regain lost ground until 2014. Tech stocks far and wide were affected, prompting wide scale panic among their shareholders.
In December 1999, Microsoft stock eclipsed $58 per share, adjusted for stock splits. One year later, after the dotcom bubble burst, the stock had dropped more than 50%. It was a low point for Microsoft shareholders.
Fast forward 23 years and you might be happy to have secured Microsoft for $58 per share. Today, a share of MSFT sets you back $320 per share. Had you bought Microsoft at its 1999 peak, you’d have eventually made money—just by waiting for the recovery.
The story is more compelling if you’d practiced DCA through the dotcom bear market. Say you invested $250 monthly in Microsoft between December 1999 and December 2004. You’d have spent $15,250 and amassed about 535 shares. Today, that portfolio would be worth about $170,000, not including dividends.
2. Walmart
Bear markets create buying opportunities for recession-resistant stocks, too. Let’s look at mass retailer Walmart as an example.
In September 2008, Walmart traded for about $60 per share, adjusted for stock splits. A bear market then pushed the stock price down to about $47. Share price would then linger between the high-$40s and the mid-$50s until 2012.
Had you invested consistently in Walmart during that bear market, you’d have built a position with an average cost per share of around $50. Today, Walmart trades for about $150.
With inflation running high at 4.9%, dividend stocks offer one of the best ways to beat inflation and generate a dependable income stream. Download Five Dividend Stocks To Beat Inflation, a special report from Forbes’ dividend expert, John Dobosz.
Frequently Asked Questions (FAQs)
With inflation running high at 4.9%, dividend stocks offer one of the best ways to beat inflation and generate a dependable income stream. Download Five Dividend Stocks To Beat Inflation, a special report from Forbes’ dividend expert, John Dobosz.
