Who's Afraid of the Bear Market?

by: The Moneygardener January 09, 2008 | about stocks: GE / JNJ / PCA / PG / SMG / WAG    

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Bear Market: A market condition in which the prices of securities are falling or are expected to fall. Although figures can vary, a downturn of 15-20% or more in multiple indexes (Dow or S&P 500) is considered an entry into a bear market.

Recession: A significant decline in activity spread across the economy, lasting longer than a few months. It is visible in industrial production, employment, real income and wholesale-retail trade. The technical indicator of a recession is two consecutive quarters of negative economic growth as measured by a country's gross domestic product [GDP].

These two terms are usually taken in investing to have negative connotations. Anyone who is long the market probably does not want either one of these scenarios to occur. However, is this reaction really justified? If a bear market or recession or both occur will the net long term results on my investments be negative? Is this something I should be afraid of?

Well, I've never invested through either of these scenarios, so I cannot be sure. Let's assume that we went into a bear market in equities while the North American economy dropped into recession. How would this affect my non-registered portfolio? These might be some of the likely advantages and disadvantages of such a situation:

Disadvantages

  • Portfolio paper value might shrink for the duration of the bear market due to negative investor sentiment and shrinking earnings growth.
  • Company earnings from North American activities might grow slower or even decline for the duration of the recession.
  • Company dividend increases might grow slower, stay flat, or even decline for the duration of the recession.
  • Commodities could fall substantially, due to falling demand, causing stocks like Petro Canada (PCA) to plummet.
  • Watching the daily happenings in the market would be depressing.
  • Total market returns for this period should be negative, and could be below -10% annually.
  • This period will be a bad time to sell investments.

Advantages

  • Quality dividend growing stocks may fall to very low levels causing buying opportunities. These stocks may be able to be bought for low prices, and high yields.
  • Some stocks like Procter & Gamble (PG), Johnson & Johnson (JNJ), and Walgreen (WAG) may outperform due to their defensive nature and non cyclical earnings streams.
  • Non-North American business should still grow, albeit slower.
  • Dividend payments will still come, and dividends will still grow, perhaps at a slower pace.
  • Energy prices might fall causing a significant reduction in input costs for most companies.
  • A bear market and recession are usually followed by a period of growth and prosperity.
  • Long term this period should actually boost my returns if I continue buying. In other words, this period should be a good time to buy investments.

Looking at things this way, strictly from an investment perspective, I hope this occurs. To me, the advantages outweigh the disadvantages if, and only if, I behave in this way:

  • Do not sell any investments
  • Keep buying companies that grow their dividend every year, that I deem to be cheap
  • Don't let bad market sentiment get me down

The earnings of the stocks that I currently own should be fairly resilient to a recession. I would imagine my paper losses would be the greatest on economically sensitive stocks like Petro Canada (PCA), Reitmans, General Electric (GE), and Scotts Miracle Gro (SMG). Several of the remaining stocks might actually be viewed as safe havens in times of trouble.

What we should probably fear more as investors is a bubble situation as occurred in the late 1990's. Although a different set of adaptive behaviour might be required in a bubble. Judging by stock valuations currently, I am pretty sure we are nowhere near a bubble.

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This article has 2 comments:

  •  
    Jan 10 08:25 AM
    You must be kidding! Keep your portfolio while you know the bear market is in store.

    Let me ask you this: What if your stock drop by 70%? Still hold until the next bull?

    You should retract this article. You are silly!
    Reply | Link to Comment
  •  
    Jan 10 08:26 AM
    Btw.... Where did you learn your Investing Rules?
    Reply | Link to Comment
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