Saturday, July 12, 2008

Value In A Bear Market

It became official this past week with the S&P 500 Index entering a bear market by declining more than 20% from its high in October of 2007. The only way to have escaped damage to an investment portfolio in this market would have been to sell out of equities completely in October. Realistically, no investor has successfully timed in AND out of market cycles from peak to trough. Certainly there will be the occasional investor that brags about the time they went to all cash. What they don't say is that they went to cash months or years before the market top or they remained in cash through the entire next bull market.

Now that the markets are in bear market territory several questions come to mind.
  1. How long will the bear market last?
  2. Should one invest in stocks now?
Answering the second question first. One key aspect to investing is to buy low and sell high. With many stocks down significantly from their market highs, investment opportunities do exist in high quality firms where the potential purchase price is far below a company's fair market value or below its intrinsic value. For example, most banks will survive the current financial disruption. Everyone still needs to eat and wash their cloths. This is a reason stocks like Wal-Mart (WMT) continue to do well. Is there value in staples companies like Procter & Gamble (PG)? InBev (INB.BR) certainly believes there is value in Anheuser Busch (BUD).

So, should one invest in stocks now? If an investor's goals and objectives, along with portfolio allocation analysis, suggest equities should be a part of an overall portfolio, then value can be uncovered in some stocks. To potentially minimize additional market contraction, using an investment discipline focused on strong dividend growth companies and/or strong cash flow companies, can uncover attractive investment opportunities. An added benefit to owning high quality companies is their stock prices tend to hold up better in down markets.

Back to the first question of how long will the bear market last. No one can accurately predict the actual end date of this current bear market. However one can learn something by looking at the history of past bear markets.

The recent issue of The Outlook ($) newsletter by Standard & Poor's looks at the magnitude and duration of the last nine bear markets since 1956. A common question asked today is what generally occurs after the market declines 20%. S&P notes:
  • [the bear markets] have varied in magnitude from the decline of 20% for the market in 1990 to the 48.2% from 1973 to 1974 and the 49.1% from 2000 to 2002.
  • History shows that the S&P 500 didn’t cross the 20% threshold until two-thirds of the way through the overall decline.
  • From 1956 to 2001, these nine bear markets lasted an average 14 months, yet it wasn’t until the 9th month after the market top that the S&P 500 finally fell into bear market territory. This time was the same as the average: We topped out on October 9, 2007, and crossed into bear market mode almost exactly nine months later.
The below table outlines the market performance at various time periods following the 20% correction.

(click on table for larger image)

historical bear market table
Out of the nine bear market since 1956, there were only two periods where the market was down further after 12 months, the 1956-1957 bear market and the 1973-1974 bear market.

Who knows if the worst is over, but history would suggest a large part of the decline is already priced into equity prices. Could they go lower--certainly. However, using a disciplined investment approach could uncover some rewarding investment opportunities.


Breaking the 20% Threshold

The Outlook
Standard & Poor's
By: Sam Stovall

(I hold a long position in Wal-Mart and Procter & Gamble)

1 comment :

Anonymous said...

If you have the cash available then now is a great time to take advantage of great values in this bear market.