Bear Markets
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What is a Bear Market and what causes it?
By definition, a Bear Market is when the stock market falls for a prolonged period of time, usually by 20% or more. Its the opposite of a Bull Market.
This sharp decline in stock prices is normally due to a decrease in corporate profits,
or a correction of overvaluation i.e.stocks were way too expensive and needed to drop to more reasonable levels. Investors who are scared by these lower earnings or lofty valuations sell their stocks causing prices to drop. This causes other investors to worry about losing their money they've invested, so they sell as well...and so the vicious circle begins.
One of the best examples of such an unfriendly market were the 1970's during and after the oil crisis, when stocks dropped and went sideways for well over a decade. Experiences such as these are generally what scare potential investors away from investing, and which keeps the bear market alive since there are more sellers than buyers.
How does a Bear Market affect my investments?
Generally, a bear market will cause the securities you own to become undervalued. The decline in value may be sudden, or it may be prolonged over the course of time, but the end result is the same: The stocks you own are worth less, at least according to the market.
This leads to 2 fundamental truths:
- A bear market is only bad if you plan on selling your stocks or need the money immediately.
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Falling stock prices and depressed markets are the friend of the long-term investor.
In other words, if you invest with the intent to hold your investments for years down the road, a bear market is a perfect opportunity to buy stocks at way lower prices.
It always amazes me that the so-called experts advocate selling after the market has fallen. The time to sell was before your stocks lost value. And the time to buy is now (!) when stock prices are low.
So what should I do with my money in a bear market?
The first thing you need to do is find good and solid companies that are still going to be fine in the long-run. If you want to play it safe, choose so-called Blue Chips or Global-Players like General Electric, Johnson&Johnson or Gillette. Because if the market crashed tomorrow and caused Gillette's stock price to fall 30%, people are still going to buy razors. People are also still going to buy computers and use the products of Microsoft etc. So the basics of the businesses haven't changed.
This proves the 3rd. fundamental truth of the market:
- You must separate the stock price from the underlying business. They have very little to do with eachother over the short-term.
When you understand this, you will look at falling stock markets like a clearance sale at your favourite furniture store. Load up while you can, because sooner or later, prices will go back up again. In history they always have.
Can I also profit from a bear market while stocks are falling?
Yes you can! You don't necessarily have to wait until stock prices are at their lowest level again before profiting from a market that's going down.
With Put Options you can profit from a bear market while stocks are on their way down. This is also the correct way to use this investment tool, because once stocks are down and on their way up again you would then change to Call Options to profit from an up-market.
Ricky Schmidt
March 17, 2005
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