Friday, November 28, 2008

Bear Market Recoveries: Returns Occur Early In New Cycle

Once a bear market cycle ends, a large portion of the returns in the next bull market occur early in the new bull market cycle.

Schwab Center for Financial Research, with data from Morningstar, Inc. (MORN) reviewed total monthly returns of the S&P 500 Index ($INX) from January 1926–September 2008. Cash is represented by total returns of the 30-day T-bill. The 15 historical bear markets analyzed are defined as periods with cumulative declines greater than 10% and durations of at least six months, and do not include the current market.

As the below table notes, a large portion of the bull market returns historically occur in the first year following the bear market.

(click to enlarge)

bear market recovery table
Given the recent market volatility, it is prudent to review ones overall asset allocation. During this review, one of the hardest temptations to overcome can be the desire to move more investment assets to cash. Certainly if funds are needed near term, cash needs to be set aside. Keep in mind though, large returns tend to occur in short bursts and early in the new bull cycle. In just the last five trading days, the S&P 500 Index is up 19.1%.


Ready for the Rebound? (PDF)
By:Bryan Olson, CFA
Charles Schwab & Co.
November 17, 2008


yanquiCFA said...

Another piece of "Buy-and-Hope" propaganda. If you want to be balanced, assume each of the cash holders in the study went to cash at the same time intervals after the bear market started, avoiding the bear market losses after that point. Then run your analysis accounting for the beginning principal differential at the end of the bear market. THAT would actually be a more fair study. Remember, even if the cash holding investor has a lower return after the bear market ends, he has more principal to grow because he likely got out early. The study as presented is asymmetrical wrt investment strategies.

David Templeton, CFA said...


I agree one could look at what you propose. Note, whether it is percentages or absolute dollars, the overall time weighted percentage return is what is relevant.

The risk of a strict market timing approach is I do not know an investment strategy that has worked in getting someone out of the market the day before the bear market begins. Also, no strategy is available that gets you into the market when the bull market begins.

If you invested $100 in the stock market in 1926 and simply kept your money invested through 1993, your investment would be worth $80,000. But if you tried to time the market and "missed" the 30 best months, your $100 would have grown to only about $1,200 the same return you would have received investing in U.S. government T-bills.

What if market timing kept you in the market all the time except for the 30 worst months from 1926 through 1993? Your $100 initial investment would have grown to around $8.6 million. I wish I knew what investment strategy would deliver these results.

The point is, it is virtually impossible to time into and out of the market so one enjoys the big up days and avoids the large down days. Returns, either up or down, tend to occur on a handful of days over the course of a year or month etc.