History Lesson & Bear Market Advice

History tends to repeat itself. The economy and the stock market are no different. We have had, and will continue to have, economic expansions followed by recessions. To give you an idea of what to expect, consider the last recession.

It was the result of another bubble bursting (in Silicon Valley, not housing). In 2 1/2 years (early 2000 through late 2002) the S&P 500 fell by 50.5%. Investors felt massive pain and many took dramatic action by getting out of the market. That was the right emotional decision in their minds at the time (because they didn’t want to take any more pain) but it backfired financially.

After a 2 1/2 year bear market, the S&P 500 bottomed in October 2002 and rose by 105.1% over the next 5 years. Those investors who stuck with the market and even added to their investments as prices dropped reaped huge rewards. Those who exited the market out of fear missed out.

With the market down more than 35% in the last year, what should investors do now? For the answer all we need to do is look at history. About 97% of all five year periods have seen the stock market go up, as have nearly 100% of all 10-year periods. If you are a long term investor (5 year time horizon or more by my standards) the numbers imply you should stay in the market.

You may have noticed that Warren Buffett has been very active in the market in recent weeks, investing billions of dollars. Is he crazy? No, he simply knows that when prices drop significantly there are bargains to be had. Future stock price returns are going to be higher during bear markets than bull markets because prices are lower. It isn’t any different from buying a house, a car, or a cart of groceries. When things go on sale, we should buy more of them. Have you ever been to the store, seen your favorite cereal on sale, and bought a couple extra boxes than normal because of the price? I know I have.

Stock investing shouldn’t be any different than grocery buying. It is true that it all sounds so simple, but isn’t because emotions and psychology come into play more with stocks. Warren Buffett has the perfect temperament for the market, so he can step in and buy when everyone else is selling. His famous quote is “be greedy when others are fearful and fearful when others are greedy” and he is acting on that principle through all of this.

It is not an easy thing to do, though. Most people want to get out of stocks right now, not sit tight or buy more. That is what their emotions are telling them to do. Unfortunately, it is not the right decision to make for an investor who has the time to wait things out for several years.

I will conclude with a story. During the first week of October 2002 I wrote a letter and sent it out to about three dozen friends and family members. I explained that the stock market was very depressed but that there were tremendous investment opportunities out there. I made the case that allocating money with Peridot Capital at that time would likely prove very profitable over the coming years.

Guess how many people invested new money with me? None. The responses were predictable, although I had hoped some would take me up on my offer. Many recipients simply ignored the letter completely. Some responded by telling me that they had sworn off the market after they had lost so much. One declined my offer by explaining “As you know, this is not the easiest environment to lure potential investors.” Very true, but ironically, it was the perfect time to do so.

A week after I sent out that letter, the S&P 500 index bottomed out at 768.63 on October 10, 2002. Over the next five years the market more than doubled and reached an all-time high of 1,576.09 on October 11, 2007.

So my bear market advice in as few words as possible would be:

1) If you have a 5-10 year investment time horizon, or longer, do not sell your stocks simply because prices have fallen significantly and it is scary to watch the daily market swings and read the dire news headlines.

2) If you have the financial means, and are comfortable doing so, adding to your investments during times like these will most likely prove very profitable as long as you can take a long term view on the investment.

3) Don’t pay attention to the daily market volatility and headlines if you don’t have to. If you are investing for 5 or 10 years, who cares what the market does today, this week, or this month? It’s irrelevant. Warren Buffett often says that he wouldn’t care if the market shut down for a few years and reopened because he is confident in the long term prospects of the stocks he owns.

If only we could make that happen in times like these. It would ease the short term pain and also ensure long term gain.

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7 Thoughts on “History Lesson & Bear Market Advice

  1. Cristian Nicola, NY,NY on October 8, 2008 at 8:04 AM said:

    I am almost compelled to use some expletives regarding your article.

    A math lesson says to us that assuming you were good enough to invest in the last bottoming process in 2002 – 2003 you would be now (5 years later!!!!) break even at best. Unless you bought IN Oct 2003 that would hold true.

    So now what? You just lost 5 years of investing (without even counting inflation and pure T-Bills returns), got a lot of grey hairs and then the hope that the next 5 years will be better.

    Don’t get me wrong: I am not saying you cannot make money in the market. I have friends who bought in 2003 and sold in 2007 … But average Joe does not know how to do that … Not to mention people that will need to retire at a given point and it will really be a crapshoot as to whether they retire on a peak or a valley …

    So please stop this stupid “there is value out there”. In the long run we are all dead …

    P.S. You could add to the math lesson the discussion of whether whatever is left of the economy after all this is said and done will justify same valuations as we used to see in 2006 (I don’t think so but I am sure they will be a new wave of suckers).

  2. Chad Brand on October 8, 2008 at 8:39 AM said:


    I think you may have missed my point. The question investors are facing today is whether or not to listen to their emotions and get out of the market.

    I used the 2002 example to show that people selling today will most likely be worse off than those who don’t.

    Let’s consider 2 fictional people who each had $100,000 in the market in March 2000. By October 2002 they only had $50,000 as the market dropped by 50%.

    Investor A was very scared, sold their stocks, put the money in the bank, and earned 3% interest for five years. By 2007 they had about $58,000.

    Investor B held their stocks, rode the next bull market, and by 2007 had about $102,500.

    You are right that Investor B only had an extra profit of $2,500 (vs their prior peak) by waiting it out for 5 years, but they were a heck of a lot better off than Investor A.

    And if one had added to their investments after the drop, they would have fared even better.

    There is no doubt that over the long term, investing in the market when it is down is a very profitable move. Don’t take my word for it, just look at the numbers throughout history… they prove it.

  3. Anonymous on October 8, 2008 at 8:45 AM said:

    What Chad is saying is that long-term investors can wade through the troughs. If someone is planning on needing income from their investments (i.e. retiring) in the next 5-10 years then that person should not be in all equities.

    What I do during these market times is look at the graph of the history of the DJIA or S&P 500. The media would love us to think that this current correction is unprecendented since the Great Depression, but 30-50% market drops are not that unusual. Chad probably knows the exact frequency.

    The U.S. economy, like all economies, has shown to go through long-term cycles. The market usually does not go much past the previous bottom, so I'm watching Dow 8000-8500 as a potential bottom, although it may not get that low. Then history would show that we've got 5-10 years to get back around the previous top (Dow 14,000), which should mean some pretty good annual returns between now and then

  4. Cristian Nicola, NY,NY on October 8, 2008 at 9:00 AM said:


    I agree that if you are already invested you should not sell just because you are panicking …
    But in your example if you had 100k cash in 2000 and put it in savings with 3% you would have had roughly 121k in 2007. A heck of a lot better than riding out the market for 7 years and aging 14 years in those 7 🙂

    And again your example stops at 2007. If you kept them though now you would be back to 50k … In the market you can always be right but it all depends on when you need to be right (these days you could be right and wrong in the same day).

    If you look at the long term trend of S&P on a weekly chart it used to keep above 400 dma going back to 1988 so it kept a moderate uptrend … In 2001 it dipped under and now it did again. So the question is whether we are looking at a much more volatile environment going forward where these cyclical things are the norm … If so then the old LT investment strategy is outdated.

    I invested for the first time in May this year (small amount). I am down since then quite a lot … I am loth to cut and run but also I am thinking that I will need to wait out not only the bottom but also a lot of the market upside just to BE. Again all about timing.

  5. Chad Brand on October 8, 2008 at 9:51 AM said:


    I highly doubt the viability of a long term investment strategy is outdated. The market rises 4 years out of 5. There is no reason to think that long term investors who buy stocks won’t outperform all other assets classes over extended periods of time. It has always been that way, and I don’t see why that would change.

    You are right that investment returns are all about timing in the short run. That is why investing when stocks are down a lot (October 2002) yields far greater returns than investing when they are sky-high (March 2000). By your logic (market dipped below 400 DMA the last time in 2001 — they were forming a cyclical bottom), you should be adding to your investments from earlier this year to reduce your cost basis and the amount of a rebound you need to reach breakeven. Of course, that assumes your time horizon for needing that money is in years, not days, weeks, or months.

  6. Cristian Nicola,NY,NY on October 8, 2008 at 3:29 PM said:

    Hi Chad,

    Every time you enter a trade you have (or should have) an entry and exit point both on the upside as well as on the downside.

    Your thesis gives only the entry point and is not necessarily bad. The problem is the exit point will determine whether you are making money or not. With the 2001 entry and 2008 exit you would have lost money (and even with 2007 would have barely made any money). Same thing with entering now and exiting say 5 -7 years from now during another cyclical downturn (obviously no idea when next one will be 🙂 ).

    Your average Joe most likely they will pick the worst entry AND exit points since they are usually media driven (see Cramer and his nonsense). To Anon’s comment, I have heard of a lot of people out there who are close to retirement and yet they were in stocks !!!!

  7. Anonymous on October 11, 2008 at 10:59 PM said:

    Cristian and Chad are both right.

    A naive buy-and-hold strategy would have returned zero from 5/03-10/10/08. But Chad rebalances his portfolio, so profits are taken periodically.

    Cristian is right that 2000-10/2008 has been a horror show for equity investors. I mean, for the TEN YEARS ended 12/07 or 12/08, US Treasuries have beaten US stocks. Same for the UK market. The academics that wheeze smugly about the equity risk premium should be ashamed. It cries out for people to DIVERSIFY. Why is earning 5.75% in govt-guaranteed agency mortgage-backed securities so horrible? Do we all have to risk every dime for a few higher percentages in returns?

    Also, Chad, I’m eagerly awaiting your next CHK research note after CEO Aubrey McClendon has been forced out of the stock by margin calls. Maybe those conflict-of-interest CNBC ads about “me and my friend Boone Pickens” will stop running…


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