Perspective matters a great deal. How you view the market or how you interpret what’s happening can influence your decision-making for better or for worse.
Take bear markets, for instance.
These are the thoughts of pessimists:
- Bear markets bring destruction and pain
- This one could be the worst crash in a generation
- The stock market may never recover
- Some stocks might go to zero.
These are the thoughts of optimists:
- Bear markets shake-out the excess, curb excessive risk-taking and other reckless behavior.
- They are as common as dirt for the lifetime investor
- The stock market has recovered from every bear market in history
- They allow good companies to steal marketshare, thus positioning their earnings and sales to grow to new heights during the next recovery.
- The volatility of bear markets is what fuels the high returns of the stock market.
- You make more money buying stocks in a bear market than you do in a bull market.
In the Bear Market Survival Guide, I introduced the idea that bear markets are dangerous, but create rare opportunities. Pessimists focus on the danger. Optimists focus on the opportunity.
The opportunity comes in two forms.
First, you can try to profit from the downturn by entering bearish positions. Swift drops can bring big profits to traders with short positions. I acknowledge the potential profits waiting for those on the right side of the trend when prices plummet. But at the same time, I’m the first to point out the utter difficulty of staying bearish in a downtrend. As the last week will attest, sharp rallies plague downtrends, threatening to shake bears out of their positions.
A second opportunity arising in bear markets is that of buying shares at fire-sale prices. You don’t get the chance to buy major indexes and blue-chip stocks at 20% to 50% discounts in a bull market. Such bargains only come on the back of widespread panic.
Of course, talking about buying equities when they’re on sale is easy. Having the courage and conviction to pull the trigger while the world is burning is quite another.
To make putting capital to work when prices are low, I like the idea of scaling in at different prices to create win-win scenarios.
The Seed Sower
The biggest problem with buying during bear markets is that we don’t know when the bottom is in. Sometimes we fall 10%. Other times we decline 20%. On a rare occasion, we’ll drop 30% or more. Here is the average frequency of drawdowns in the S&P 500 since 1950.
- Decline of 10% or more once every 2 years (aka correction)
- Decline of 20% or more once every 7 years (aka bear market)
- Decline of 30% or more once every 12 years (aka crash)
Due to the higher volatility of the Nasdaq and Russell 2000, they actually experience bear markets and crashes more frequently than the S&P 500.
Do you see the folly of waiting until the S&P 500 is 30% of its highs before buying? You might be waiting a decade to get a shot! On the other hand, if you buy when the market is only 10% off its highs, you might be getting in too early if it ultimately ends up falling 35% before finding a bottom.
The idea behind the seed sower is to scale in at set intervals.
Buy some when S&P 500 is down 10%. If it recovers immediately, then you at least planted some seeds.
But if the 10% drop morphs into a 20% decline, then you can buy more (that is, plant more seeds) at even lower prices.
That’s a win-win.
Maybe you split your cash hoard into 4 buckets and invest one-fourth each time. You choose the intervals but something like -10%, -15%, -20%, -30% might suffice.
Remember that you don’t harvest in the same season that you plant. Sometimes it can take a while before your investments bear fruit. But if you’re not willing to sow when prices are down, then you won’t have anything to reap when prices are up.
For those keeping score at home, the S&P 500 got down 10% at Friday’s lows. The Russell 2000 was 20% off the highs. Both drawdowns are significant enough for the seed sower to have started putting money to work.
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