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Daily Traders Edge

Stock investors can no longer ignore the next bear market

October 02
10:18 2018

The biggest obstacle to long-term investment success is “the dogma that you must beat the S&P 500 during bull markets.”

So writes Brian Livingston in his new book “Muscular Portfolios: The Investing Revolution for Superior Returns with Lower Risk.” I couldn’t agree more.

Livingston is an investigative journalist who has focused his energies in recent years on the investment industry. He is president of the Seattle chapter of the American Association of Individual Investors, and I think highly of both him and his work. (For the record, I have spoken to that AAII chapter, but I have no financial interest in his book sales.)

Livingston’s insight is that beating the S&P 500 SPX, -0.10%  during bear markets is far more important than during bull markets, for two reasons. The first is mathematical: Big losses require even bigger gains to recover, and at some point the required gains become so large as to become improbable. So if you lag during bear markets you have to beat the S&P 500 by a lot during bull markets to come out ahead over the long term.

To illustrate, consider the investment newsletter among the several hundred monitored by my Hulbert Financial Digest that lost the most — 79% — during the bear market from October 2007 to March 2009. (Out of charity I won’t mention its name.) Care to guess what its gain since March 2009 would have to be in order to merely equal the S&P 500’s return over the entire period since October 2007? More than 1,000%. (It has not come close, needless to say.)

To put that in context, you should know that the S&P 500’s return since March 2009 has been “just” 380%. In other words, this huge bear-market loser would have had to beat the subsequent bull market by nearly three to one just to equal the S&P 500’s return over the entire bull-and-bear cycle. That’s an almost-impossibly high hurdle.

The second reason why it’s more important to limit bear market losses is behavioral: It’s the rare investor who can tolerate big bear market losses. All too often, investors end up throwing in the towel during the latter stages of a bear market and so miss out when the market recovers.

What is the threshold beyond which the typical investor is unwilling to tolerate a loss? Livingston quotes Ben Carlson, director of institutional asset management at Ritholtz Wealth Management: “In a 10% correction, people for the most part are OK. At 20%, people get a little edgy. When you get to the 30%, 40% loss range, people say, ‘Get me out. I tap out. That’s it’.”

As a reminder, the average stock lost 49% in the 2000-2002 bear market (even after including dividends), and fell 55% in the 2007-2009 bar market.

Continue Reading at Market Watch

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