Great Investors Know a Bear When they See One

“Investors are hiding out in cash: Assets in Money Market Funds surge past $3 Trillion”

– Liz Moyer, CNBC.com, Jan. 14, 2019

In last month’s article, we focused on “Avoiding Surprise” as one of the great qualities to adopt for anyone who wants to become a great investor. This month, we analyze investor psychology in the face of the latest Bear Market in equities.

If it Claws like a Bear…

Given the robust start to 2019 for equity prices, the Bear Market of late 2018 may already begin to seem like ancient history.  However, the fact is that the S&P 500 experienced a decline of 19.8% between September 20, and the “Christmas Eve Massacre” of last year.

Bear Market: condition in which securities prices fall 20% or more from recent highs amid widespread pessimism and negative investor sentiment. “

The official definition of Bear Market is a period of time during which equity prices decline by 20% or more, so for many this will not go down in the record books as an official “Bear Market”.  However, there is an old saying that “if it looks like a duck, swims like a duck, and quacks like a duck, it’s probably a duck.”  Likewise, if it claws like a bear, lumbers like a bear, and growls like a bear, it’s a bear.

As a result, we feel compelled to update our favorite chart below, depicting the history of equity Bear Markets over the last 100 years:

Please note that we include here 4 episodes during which the S&P 500 declined by slightly less than 20%, simply because they felt like Bear Markets too.  In addition, this chart does not include dividends in the S&P 500 return, which makes these Bear Markets appear worse than they really were.  As a result, this chart brings the investor closer to the actual emotions experienced in real time when the bear actually strikes.

The Bear and Investor Psychology

While some may debate whether the most recent decline was in fact a true Bear Market due to the fact that the 20% threshold was not breached, it appears clear that investor psychology is currently displaying all of the classic hallmarks of a bear market.

Typically, equity bear markets are accompanied with a high level of existential terror and doomsday thinking among investors.  It seems we can check that box, as investors appear to expect Armageddon in the economy and investment markets imminently. Whether it be discontent with Donald Trump, concern that the Federal Reserve will strangle the economy with higher interest rates, anxiety over the government shutdown, trade wars, or the threat of a global economic slowdown, investors seem to be growing increasingly prone to panic.  It seems clear that the hangover from the financial crisis of 2008 still persists, and Americans are still waiting for “The Other Shoe to Drop”, and the horrible unfinished business that crisis may still wreak on our economy.  One would think that a decade in which equity prices have quadrupled might have strengthened the public’s temperament in the face of normal market setbacks, but judging from the anxiety over this recent decline, that kind of confidence is still lacking.

As proof of this fearful mindset, consider investor behavior leading up to the “Christmas Even Massacre” in equity prices.  As equity prices got cheaper and cheaper, making valuations more and more attractive, the investing public ignored this opportunity, and instead rushed out of equities at any price, as cash piled up on the sidelines.  As CNBC broadcast on January 14^th:

Investors are hiding out in cash: Assets in money market funds surge past $3 Trillion.
Assets in money market mutual funds have swollen to $3.066 Trillion, their highest level since March 2010, driven by retail investors. The money fund assets had spent much of the last decade in the $2 trillion range, but tracked above $3 trillion again in mid December, coinciding with a late 2018 market downturn. Nearly three quarters of the $183 billion that flowed into money market funds since the end of the third quarter was to retail funds, not institutional, according to ICI Data.

There is an old saying on Wall Street that a Bear Market is an episode in which “stocks are returned to their rightful owners”.  Something tells us that these folks who were rushing to sell their equities, and stockpile these enormous cash balances, do not qualify as “Rightful Owners” of equities.  Something also tells us that, when many of these people come back to their senses and reinvest this cash back into equities, it will provide an ample supply of “fuel” to fire the engine of growth in equity prices.

Temporary Decline, Permanent Advance

We will let the market historians debate the facts of the equity market decline of late 2018, and decide whether to call this episode a Bear Market or not.  Although it is not over yet, as the S&P 500 has not yet reached its prior high of September 2018, equities appear well on the way to making this episode history, after a significant recovery in January.

Instead, we will focus our attention on the real message of our trusty Bear Market history chart above.  Since World War II, despite temporary setbacks in equity prices, the S&P 500 has slowly but constantly marched forward from under 20, to over 2,600 today.

Historically speaking, the declines in equity prices have been only temporary, while the advances in values and dividends have been permanent.