Sometimes the market feels like Opposite Day.
Stocks rose Tuesday morning after the worst inflation numbers in 40 years. (Of course, they turned lower soon after.) Then, traders had enough and sent stocks surging higher again on Wednesday.
When things get choppy and stocks head lower, two dreaded words enter the conversation: bear market.
Instead of embracing fear and entering sell-off mode, Research Analyst Matt Clark and I look back at some recent bear (or near-bear) markets to see what we might expect if things head south this time around.
Check it out in this edition of Investing With Charles.
What We Learned From the COVID Crash
Matt Clark: Let’s start with the most recent bear market back in 2020 during the COVID crash:
Stocks were up, and then COVID-19 cases ticked up. We started seeing lockdowns. Then we started seeing it hit the United States in February and March.
At that point, the market just decided it was time for a break. Starting right around March 1, the S&P 500 started moving into negative territory. When it was all said and done, total returns from February 2 to March 22 showed the S&P was down about 30%.
Charles: In just the blink of an eye.
That was a very interesting bear market. You started getting those winds of [the pandemic] coming in February when they started locking down parts of Europe.
Silly us in America were like, "Oh, that's interesting. Italy's on lockdown. Well, what's for lunch?" It never occurred to us that the same would happen on our own shores shortly after.
Of all the bear market scenarios we're looking at, the 2020 corona crash is the least relevant because it was a unique, once-in-a-century pandemic that we were sorely unprepared for.
And then that was, of course, remedied by the most aggressive Fed stimulus in the history of the Federal Reserve itself. This is one of those case studies that is maybe interesting in an academic sense, but it's hard to see history repeating like this.
Matt: Yes. This was a precipitous drop in a very short amount of time, but then things balanced out and the market rose back up into positive territory. And actually, I think closed out 2020 with a gain.
2018’s Near-Bear Market Looks Familiar
Matt: This is not your typical bear market, but I thought it was a good barometer. I’m talking about the third and fourth quarters of 2018. We came very close to a bear market.
Looking at the second half of 2018, the S&P 500 rose as much as 8% by October. And then we started to see a downward trickle. It got to as low as about 14% down — in correction territory, but not quite bear market territory.
Charles: Yes. I think this is an interesting example because there are some parallels to today.
What was happening in 2018, after years of extraordinarily loose policy... Remember, after the 2008 meltdown, the Fed did what was, at the time, an unprecedented amount of stimulus: 0% interest rates, quantitative easing, QE Infinity. You remember all of that.
It took them years to scale it back. And the Fed started getting aggressive around 2018.
It's hard to ever pinpoint what caused a bear market or correction, but that was what changed market perception. There was a lot of fear that the Fed waited a little too long. And now they have to go a little too aggressively.
The higher the Fed raises rates is bad for earnings. It's bad for the present value of future earnings that you discount to today's prices. It's bad for stock prices.
That's similar to what we’re experiencing today. Inflation wasn't raging out of control, and we weren't coming off of a pandemic. But we were dealing with extremely loose monetary policy.
It was within rounding of an official bear market. And if you were trading at the time, it felt like a bear market.
It’s an interesting parallel. Is this the exact model we're looking for? I don't know, but I think that's a good example.
I think this is a decent case study of what this year could feel like.
Could We See Another Dot-Com Crash?
Matt: The last bear market I want to highlight occurred from May 2000 to April 2003. This is the famed dot-com bubble.
Stocks propped themselves up a little bit in the positive territory and then went down.
We saw some bumps higher throughout the bear market, but, at the end of the day, markets dropped as low as 45%.
Charles: We had a bona fide bubble in the dot-com stocks. And in a real way, tech in general. Looking at the market in general, stock prices got ridiculously priced. The tech sector in particular was absurd.
I was just cutting my teeth in the industry at that point. I looked up Yahoo!, which was still a stock that mattered back then. It was trading for 30 times sales!
And I remember some analysts trying to justify a valuation of 30 times sales. I was fresh out of college, and that still looked a little bit ridiculous to me.
But what happened in 2000? The bubble finally burst. Tech stock prices became unsustainably high. And these ridiculous business models were exposed.
You started seeing earnings misses and you started seeing the game was up. People realized: "This is ridiculous. It's time to sell-out and move on."
And that's exactly what happened.
You started seeing a big tech sell-off. Blue-chips held up for a while. The non-tech stocks didn't immediately suffer.
And then we had the September 11 attacks in 2001. That caused a whole other wave of the bear market to follow because that shattered confidence.
This is relevant to today for a couple reasons. For one, we are in a bubble economy right now.
Everything is expensive: stocks, bonds, housing, cryptocurrencies… There's a bubble in everything.
It's a similar mentality as the late 1990s/early 2000s period, where you saw irrational, crazy pricing and just degenerate gambling in the market.
And today we have the situation in Ukraine. It’s scary. There's always this risk that this blows up into nuclear war. This could slide and get worse.
Well, that's analogous to the post-September 11 world where we didn't know what domino was going to fall next. Right?
If the situation we're in today evolves into a proper bear market, it's going to be some blend of what we experienced in 2018 and what we experienced in that 2000 tech crash.
How to Approach Any Bear Market
Charles: Bear markets are going to happen. Whether it happens this year or 10 years from now, we'll eventually have a bear market.
It's not the end of the world.
A lot of people make a lot of money in bear markets. Warren Buffett made out like a bandit in the 2008 bear market.
If you go into it with a little cash on hand and you're also being more tactical in nature, you can make good money in a bear market. It's nothing to be afraid of.
Matt: What's the best approach for the smart investor going into what could be a bear market or correction for the market?
Charles: The best advice is: Don't put all of your eggs in a long-only basket here. If you have some stocks that you just hold forever, that’s fine. You don't have to touch those.
But make sure you keep at least part of your portfolio in shorter-term strategies. Something that may be a couple of days to a couple of weeks or months in nature.
As we see in all these charts, nothing goes straight down. There's always bear market rallies. It could be quite profitable.
Don't fear the bear. Embrace it and be willing to go short-term.
Matt: And another key here is that: If you have a strategy, if you have a rationale, it is very important to maintain that rationale and that strategy. Don't augment it just because the market moves one way or the other.
And if you don't have a strategy, it's important to develop one. Would you agree?
Charles: Absolutely. The worst thing that could happen to you is you've been buying stocks, you've been buying some bonds, but you don't have a plan.
And so when a bear market strikes, you don't know what to do because you didn't have a plan when you bought the stocks. You never had an exit strategy. You have to have that going in.
Matt: The benefit of a strategy is that you know how much you're willing to lose, and you know how much you're willing to gain. You can limit your losses and maximize your gains.
If you don't have a strategy, that's OK. That's where we help you. We have an easy strategy that you can latch on to that has produced great gains over the years.
It’s called Green Zone Fortunes.
We give you that structure that you need to be confident going into down times in the market and to be even more confident in up times in the market. [Click here to see how you can join Green Zone Fortunes today.]
So, Charles, where do we go from here?
Charles: I expect that the market will continue to be choppy for a while. This year’s chart looks like a sawtooth pattern. It'll be up wildly for a couple weeks. It'll be down mostly for a few weeks.
Where we go from here?
Well, we trade it. We stick to our rules. We enter a trade knowing when we're going to get out and we stick to that.
Note: We didn't skip the bear market that occurred during the financial crisis of the late 2000s. If you want to see what we had to say about it, click here to watch the rest of Investing With Charles on our YouTube channel.
To safe profits,
Charles Sizemore
Co-Editor, Green Zone Fortunes
Charles Sizemore is the co-editor of Green Zone Fortunes and specializes in income and retirement topics. He is also a frequent guest on CNBC, Bloomberg and Fox Business.