BUNK 9
MAKE SURE IT’S A BULL BEFORE DIVING IN
Suppose it’s a bear market. The big, the bad, and the ugly one! Maybe you’ve stayed invested throughout—that sure hurts near term. Plus, bear market volatility is huge and scary. Should you bail, wait out the end, then get back in when the signs are clearer? (Another question: Are you that good a market timer?)
Or maybe you’re out and know you need to get back in. But when? All that whipsawing is beyond terrifying. Better to just wait until it’s certain the bear market is over, a new bull has begun, and all is clear, right?
No—as counterintuitive as it seems, risk is actually least just when sentiment is most black—right as a bear market hits its lowest depths. Clarity is one of the most expensive things to purchase in capital markets and is almost always an illusion.
No one can perfectly time a bear market bottom. Someone telling you otherwise is deluding himself (or herself) or trying to mislead you (see Bunk 11). Or got lucky once. As painful as the wild wiggles of a late bear market are in the near term, you don’t want to miss the start of a new bull market. New bull market returns are super swift and massive—quickly erasing almost all late-stage downside volatility. If you suffer the last 15 to 20 percent of a bear market, it is still, almost certainly, small compared to the subsequent initial up-leg of the next bull market.
Think of a bear market like a depressed spring. The more you push down, the bigger the bounce. It works just like that. Figure 9.1 shows this effect—a hypothetical bear market bottom/new bull. Initially, deteriorating fundamentals drive the bear. Folks think bear markets start with a bang—they usually don’t. They grind lower slowly. It’s the end when the bang comes. At a point, diminishing liquidity (like we saw in the fall of 2008 during the financial crisis) and sentiment take over from fundamentals—and, in fact, panic ensues. But panic is usually nothing but sentiment and the temporary lack of liquidity that goes with the sentiment shift and is often confused with something fundamental.
Figure 9.1 Hypothetical V-Bounce
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Right then, stocks can drop huge and fast. But as a new bull market starts, the reverse can happen just as fast—stocks zoom higher on sentiment as things aren’t quite as bad as freaked-out folks feared and liquidity returns with it. The big initial boom happens not because things are good or improving, but because they end up being not quite as much of a disaster as assumed in the panic. Stocks take off like a bullet—the shape of the new bull market about matching the speed and shape of the end of the bear. I call this the “V-bounce” effect.
(Another common V characteristic: In the late stages of a bear, when sentiment is driving big volatility, those categories that fall most tend to bounce most in the early part of the new bull. Read more on that in Bunk 19 in Part 2.)
It’s not just theory—we see the V through history. Sometimes, bear markets end in what chart watchers or technicians call a double-bottom “W”—with both bottoms a few months apart. And it can seem for a very short time like a W—but with minimal time, it resolves into a basic V pattern—and the bottom of the W portion begins to look tiny by comparison. Why? Because the real start of the new bull is massive. People are usually instead looking for the agonizingly long-term W or L shape, but I challenge them to find three examples of that ever in developed markets’ history. At a global level I can’t find one example of a long-term W or L. Of course, maybe I measured wrong and missed it—go prove me wrong. But it hasn’t happened much. And if it hasn’t much happened ever before, whatever it is, you better have a darned good reason to expect it to be the real deal now.

A Classic V

Figure 9.2 shows market returns for the bear market’s final stages and the new bull starting in March 2009—a typical V. For a period, the trajectory of the new bull nearly perfectly mirrors the late stage of the bear.
Figure 9.2 World Stocks—V-Bounce Effect 2009
Source: Thomson Reuters, MSCI, Inc.,1 MSCI World Index total return with net dividends from 09/30/2008 to 12/31/2009.
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A normal V. In one sense, abnormal, because US and global stocks had a historically massive bounce off the bottom—68 percent and 73 percent respectively from March 9 through year end—an unusually huge start to this bull.2 But the preceding bear market was huge too. The initial ascent of a new bull usually just about matches the speed, shape, and descent of the last stages of the prior bear—just what you see in Figure 9.2. Look at the very end of the bear and the beginning of the bull—almost a perfect V.
Being invested for the first initial thrust of a bull market can help eat away a big portion of bear market losses—and fast. The ancestral part of our brains says, “Yikes! We fell a lot! Let’s protect ourselves so we can’t fall more!” If we act on that, it can make us feel better immediately. But it can rob us of the huge returns we normally get off the bottom of a bear market with the V bounce.
Table 9.1 shows how massive those early returns can be—averaging 21.8 percent in the first three months, and 44.8 percent in the first 12 months. That’s big and fast. And in this case, unlike Bunk 5, the averages aren’t so misleading because the first 12 months are consistently big and fast—obviously some bigger and faster than others, but all big and fast nonetheless. A bull market’s average first year more than doubles an average overall bull market year (which, over time, doubles stocks’ long-term average—see Bunk 8). And almost half those first-year returns usually (but not always) come in the first three months!
Table 9.1 First 3 and 12 Months of a New Bull Market—A Big Early Bounce
Source: Global Financial Data, Inc., S&P 500 price return.
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And here, too, the market is tricky. Because on the occasions when the first three months aren’t so straight up, folks are prone to think it’s a sign the big boom will never come. This is just the market head-faking folks in another of its standard tactics. Sometimes when the bottom is choppy on the left side of the V it is also choppy on the right side, discouraging investors. But the V pretty much always works over a year.
Missing those huge early returns while waiting for some illusory sense of “clarity” means missing your chance to erase a big portion of your prior bear market losses. Plus, it also hurts you relative to your benchmark. If you’ve suffered the bumps and agony of a bear market, those early big returns are a welcome salve. They may not undo all of the bear market, but they certainly put you on the way. And missing them can mean it takes even longer to erase bear market losses—maybe forever.
There is no bull market “all clear” signal. If there were, we’d know, and everyone would heed it. Look at Figure 9.2 again (the 2009 bear bottom). The opportunity cost of missing even the first three months can be massive and lasting. Volatility is huge on both sides of the V bottom. It’s only in retrospect you know which volatility you’re suffering through—late bear or early bull. You can’t know, so don’t miss it. You’ll regret it later.
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