Bear Markets of the Past

The worst bear market in stock market history occurred from September 1929
through July 1932, when stock prices fell some 86%. Rampant speculation,
highly leveraged buying, and sheer panic ushered in a cataclysmic period in the
financial markets that accompanied the Great Depression. While regulatory
changes make the recurrence of such a dramatic decline in stock prices unlikely,
investors 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% (as measured by the S&P 500 Index). In dollar terms, an investor who had
$10,000 invested in stocks experienced a loss of $4,800—nearly half of the
portfolio's value. Furthermore, since 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, as an investor holding 60% in
stocks and 40% in bonds lost "only" $2,900. This elementary example
demonstrates the benefits of diversifying your program across asset classes—a
topic we'll explore in greater detail in the next section. 

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 precollapse 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 market decline. Those who got out of
stocks missed an extraordinary rebound in stock market performance. After
declining to its low in October 1974, the market (as measured by the S&P 500
Index) provided generous returns in the ensuing periods. Indeed, annual returns
averaged 14.8% over the ten years from 1975–1984, 16.6% over 15 years
from 1975–1989, and 14.6% over 20 years from 1975–1994. 

Along with maintaining patience in the midst of bear markets, investors 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 in stocks 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 69 years, the S&P
500 Index has dropped more than 7% in a single day on 14 different occasions,
with the biggest one-day fall coming on October 19, 1987, when the S&P 500
Index closed down 20%. 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 from the market, as well as an equally deft return—a nearly
impossible feat.
