Making Money in Bear Markets

Bearish - Bear market trend

Topic: Investments

R. Denys Calvin CFA

May 1, 2019

Image used with permission: iStock/Chunumunu


Print & Share

Print

Making Money in Bear Markets

It has been said that “You make most of your money in a bear market. You just don’t realize it at the time.”(1) How so?

Most obviously, in a bear market – or, more generally, any period of acute market weakness – stocks go “on sale”. The enterprising investor with spare cash can capitalize on the weakness to make quality investments at a bargain price. Doing so is an example of another investment adage to “be greedy when others are fearful”.

But what of long-term investors who are already fully-invested? How can a bear market possibly be a money-making opportunity for them?

By not allowing a market decline to frighten a long-term investor into selling, he or she rides right through the weakness and participates fully in the inevitable subsequent recovery. Moreover, by not selling, the investor is spared the near impossible task of figuring out when to buy back in, and completely sidesteps the accompanying high risk of missing out on a material portion of the recovery that is a consequence of figuring out too late. This was the point of a Nexus blog from earlier this year And This, Too, Shall Pass.

There is another sense in which the successful long-term investor makes money in bear markets: with a high-quality portfolio that declines less than the market as a whole. By not losing as much as the market declines, this portfolio has less “lost ground” to recoup during the ensuing recovery. Thus, by merely keeping up with the market during the rebound – not outperforming it – the portfolio maintains its advantage. After a few such cycles of less-than-market declines and pace-keeping recoveries, the investor with this portfolio will be well ahead.

The last 6 months or so provide a good illustration of the point. In the last three months of 2018, the Canadian stock market, as represented by the S&P/TSX Composite, suffered a loss of more than 10%, including dividends. The S&P 500 fared no better. It gave up more than 13% when measured on the same basis, and nearly 9% in Canadian dollar terms.

Putting this in portfolio terms, a passive investor who held 5% of their portfolio in 91-day Government of Canada treasury bills, 50% in an index fund that perfectly mimicked the S&P/TSX Composite, and the remaining 45% in an index fund that cloned the S&P 500, would have had a loss of just over 9%. Just to get back to “even” the passive investor needs to earn a return of 9.9% on their now-diminished portfolio. By contrast, an actively-managed portfolio that lost less in the fourth quarter of 2018 – let’s say, 8% – needs to earn a return of “only” 8.7% to get back to even.

Like long-distance runners who fall off the pace, both the passive and active portfolios have some serious ground to make up. But the active portfolio that doesn’t fall as far off the pace as the passive one is better positioned. Continuing with (and perhaps stretching) our metaphor, our active runner/portfolio will finish ahead of the passive one, merely by running at the same pace.

The metaphorical active runner in our example is the Nexus North American Equity Fund over the last 7 months. It lost 8% in the last three months of 2018, at a time when its benchmark (the passive runner) lost 9%. Since January 1st, the benchmark has gained 15.9% to the end of April. The Fund didn’t quite keep pace, earning a “mere” 15.5% to the same date. However, over the full 7-month period, the Fund still came out ahead: up 6.2% versus 5.4% for the benchmark. By losing less than the market (as represented by the benchmark), the Fund outperformed the market over the sell-off and subsequent rally.

A period of only 7 months is an absurdly short timeframe for evaluating long-term portfolio performance – analogous to judging a 26-mile marathon based on how the runners fare between mile markers 6 and 7. But it illustrates the important principle that some of the biggest gains accrue when times are tough, and not when the tailwinds are favourable.

(1)  Shelby Cullom Davis, a U.S. businessman, investor and philanthropist (https://en.wikipedia.org/wiki/Shelby_Cullom_Davis)

More Like This...

See another CRM2 blog post that may be of interest to you.

No posts found.

More Like This...

See another Foundations & Endowments blog post that may be of interest to you.

That Giving Feeling

Topic:
Foundations & Endowments, Tax Planning
Excerpt:
Summer is now a distant memory. In fact, a radio announcer declared only 77 days until Christmas. Ugh. It is usually in the last quarter of the year

More Like This...

See another Human Interest blog post that may be of interest to you.

What a World!

Topic:
Human Interest
Excerpt:
You don’t need to read a blog from your most trusted investment advisor to realize that 2020 might go down as one of the most notable and difficult

More Like This...

See another Inside Nexus blog post that may be of interest to you.

Swimming Naked

Topic:
Inside Nexus
Excerpt:
Warren Buffett has a wonderful line. “Only when the tide goes out do you discover who's been swimming naked.”

More Like This...

See another Investments blog post that may be of interest to you.

It’s a Topsy-Turvy Year: Investing During COVID

Topic:
Investments
Excerpt:
This year has been plenty weird. For starters, it feels like January was about five years ago… if you can remember it at all. Putting aside the health

More Like This...

See another Pearls of Wisdom blog post that may be of interest to you.

“Work, Work, Work, Work, Work, Work”

Topic:
Pearls of Wisdom
Excerpt:
This has been a busy year. I’ve had lots happening on the home front (a wedding!) and lots going on at the office (too long to list!) Managing work

More Like This...

See another Tax Planning blog post that may be of interest to you.

The (U.S.) Taxman Cometh

Topic:
Tax Planning
Excerpt:
Like the medical patient who expects to endure a fair bit of poking, probing and prodding from the doctor, clients of financial providers have had to

More Like This...

See another Wealth Planning blog post that may be of interest to you.

Estate Planning: Questions from our Virtual Chat

Topic:
Wealth Planning
Excerpt:
Helping clients with their estate planning is something we do here at Nexus. However, we are often involved in identifying the best tools for the

On a Side Note…

See another CRM2 Nexus Notes Quarterly article that may be of interest to you.

No posts found.

On a Side Note…

See another Foundations & Endowments Nexus Notes Quarterly article that may be of interest to you.

No posts found.

On a Side Note…

See another Human Interest Nexus Notes Quarterly article that may be of interest to you.

It’s About Time

Topic:
Human Interest
Excerpt:
Over the last 25 years, we have written frequently about time. In fact, in 2010, our annual client presentation carried the same title as this article

On a Side Note…

See another Inside Nexus Nexus Notes Quarterly article that may be of interest to you.

A Virtual Nexus Welcome

Topic:
Inside Nexus
Excerpt:
We are excited to welcome Preethi Khatri Chetri to Nexus.

On a Side Note…

See another Investments Nexus Notes Quarterly article that may be of interest to you.

Uncertainty… Who Needs It? Apparently, We Do.

Topic:
Investments
Excerpt:
It is not exactly a revelation to say that uncertainty contributes to stress. In “normal” times – take 2019, for example – three common sources of

On a Side Note…

See another Pearls of Wisdom Nexus Notes Quarterly article that may be of interest to you.

China’s Larger Role in the World; Immortality in a Test Tube

Topic:
Pearls of Wisdom
Excerpt:
Reading is one of the principal occupations in our profession. As we digest a wide range of material, interesting ideas and surprising facts – some

On a Side Note…

See another Tax Planning Nexus Notes Quarterly article that may be of interest to you.

The (U.S.) Taxman Cometh

Topic:
Tax Planning
Excerpt:
Like the medical patient who expects to endure a fair bit of poking, probing and prodding from the doctor, clients of financial providers have had to

On a Side Note…

See another Wealth Planning Nexus Notes Quarterly article that may be of interest to you.

From the Editor: Happy New *Planning* Year

Topic:
Wealth Planning
Excerpt:
As the weather cools and the leaves begin to change colour, it seems to me that fall is the more natural start of a new year compared to the start of