A Perspective on Past Bear Markets

A Perspective on Past Bear Markets

The worst bear market in stock market history occurred from September 1929 through July 1932, when stock prices fell some 86 percent. Rampant speculation, highly leveraged buying, and sheer panic ushered in a cataclysmic period in the financial markets that accompanied the Great Depression.

Although regulatory changes make the recurrence of such a dramatic decline in stock prices unlikely, you would be well served by remembering that anything is possible in the securities markets.

In the post-World War II era, the worst bear market began in January 1973 and lasted roughly 21 months to October 1974, during which the market fell some 48 percent (as measured by the S&P 500). In dollar terms, an investor who had $10,000 invested in stocks experienced a loss of $4,800-nearly one-half of the portfolio's value. Furthermore, because inflation jumped significantly at the same time, the loss in terms of purchasing power was far greater.

Holding a balanced portfolio of stocks, bonds, and cash investments can cushion the decline of any one market. A portfolio composed of stocks and bonds fared much better during the 1973-1974 bear market; an investor holding 60 percent in stocks and 40 percent in bonds lost only $2,900. This elementary example demonstrates the benefits of diversifying your investment program across asset classes.

The heartening news to long-term investors is that the market eventually recovers from its declines. However, in most cases it can take some time. For example, following the 1973-1974 bear market it took nearly eight years for the market to reach its pre-collapse peak.

Unfortunately, one of the more common mistakes made by investors during bear markets is to lose patience and sell at or near the bottom of the downturn. Many investors did just that in the 1973-1974 decline. Those who got out of stocks missed an extraordinary rebound in market performance.

After declining to its low in October 1974, the market (as measured by the S&P 500) provided generous returns in the ensuing periods. Annual returns averaged 14.8 percent over the 10 years from 1975 through 1984, 16.6 percent over the 15 years from 1975 through 1989, and 14.6 percent over the 20 years from 1975 through 1994.

Along with maintaining patience in the midst of bear markets, you would be wise to guard against being fooled by false rallies. A bear market is not typically characterized by a straight-line decline in stock prices. Rather, the market's downward trend is likely to show intermittent bursts of stock price increases, which some investors mistakenly take as the return of a bull market. The 1973-1974 bear market was replete with these so-called sucker's rallies.

Finally, it is important to note that the bulk of major market movements-both up and down-often occur over brief periods. Over the past 70 years, the S&P 500 has dropped more than 7 percent in a single day on 14 different occasions, with the biggest one-day fall coming on October 19, 1987, when the S&P 500 closed down 20 percent.

When stocks recover, it is common for the gains to be concentrated in a few days or weeks of extraordinary activity. Consequently, trying to time the markets by temporarily abandoning stocks requires a perfectly executed exit as well as an equally deft return-a nearly impossible feat.