Fool.com: What a Real Bear Market Feels Like [Fool on the Hill] April 26, 2000

FOOL ON THE HILL
An Investment Opinion

What a Real Bear Market Feels Like

By Bill Mann (TMF Otter)
April 26, 2000

We hear this data point being discussed all the time. That we're in the longest continuous stretch of economic expansion in our nation's history, that we've had a 17-year long bull market, that newer investors have no idea what it feels like for stocks to go down and stay down.

During the time I've been investing, I've seen the market drop of 1987, the doldrums of 1990, the correction in October of 1998, and our current drop in value of many share prices. Sure, these events have all stunk while they've happened. And in the middle of them, it feels like nothing will drive share prices back up.

We are pretty fortunate, here in the United States, to have enjoyed such a long economic growth period. Some countries are enduring wrenching economic contractions even now, some that have lasted the balance of a decade. For example, the Russian economy remains stagnant, and to the extent that capitalism in any legal form exists there, it has not created much in the way of wealth or opportunity for the average citizen. To my mind, this has much more to do with the absence of the rule of law in Russia than any frailties in the capitalist model.

Russia may be a special case, but there are others. Japan's major market index, the Nikkei 225, for example, has not even come close to the highs of its major market index, which it hit in 1990. Still, Japan has remained pretty stagnant in the last eight years, with the majority of the loss coming in the first two, when it eventually fell by more than 60%. There was never a big drop, just a constant and inexorable drift downward.

Nothing was spared. Real estate prices plummeted, almost no Japanese company ended 1992 higher than it started 1990. In the interim, banks have failed (and if it weren't for the financial props of the Japanese government, many more would have), and companies have had to reassess some of their basic assumptions, such as lifetime employment and large benefit packages.

This seems like a historical fact, but let's look at what the Japanese have endured, on average. Let's do this by taking a list of U.S. stocks, taking their value from the high-water point from last month. (Please note: This is in no way a prediction. These stocks are just "for examples" I have randomly culled from a list of the most widely held companies.) We will take this out a decade, applying the same loss level suffered by Japanese companies, and then add in a present value of money discount of 4% per year to take inflation into account.

Company    Values as of: Mar.2000  Mar.2010   NPV 
Procter & Gamble           59       32.45    22.47
Pfizer                     33.5     18.43    12.76
Citigroup                  53       29.15    20.19
AT&T                       51.25    28.19    19.52
Yahoo!                     199      109.45   75.80
Qualcomm                   141       77.55   53.71
If you held 100 shares of each company above, your March 2000 portfolio value would have been $53,675. In March 2010, a decade later, it would be worth $29,522 in actual dollars, but only $20,444 nominal dollars (which means after the implied rate of inflation has been subtracted out).

Seem pretty impossible? Does it seem unlikely that a list of blue chip companies such as the ones above could yield a return of -60% or less over the course of a decade? I'd have to say that such a scenario is indeed possible. After all, I've just taken the numbers from the blue chip index of the second largest economy on the planet and extrapolated them.

We get so caught up sometimes in the ups and downs of the market that we lose sight of the long-term goals of investing, which is to take some amount of money and turn it into a larger amount using methods within each individual's risk tolerance.

A great deal of people, particularly those who have been investing for less than three years, are now learning that their level of risk tolerance is much lower than they thought they had when times were good and speculative companies were going up. That's a hard lesson to swallow, to watch companies that we thought we were "buying on the dips" keep drifting downward. Some really significant companies with enormous market capitalizations have been knocked down by 60%, 70%, even 80% over the last month. And yet, just as in 1987 or 1998, the current drop will soon be a distant, hazy memory if the good times suddenly start again.

Think about that for a minute. Hundreds of companies can lose half of their values, or much, much more, but if the overall market quickly rebounds, this pain will, for a majority of people, quickly be forgotten. It happened in 1987, when the market recovered everything lost in a period of months (and the Dow Jones in fact closed up for the year), it happened in 1998, which took even less time, and was followed by the explosion in values in 1999.

That's partially due to our conditioning to, in fact, buy on the dips. But as the Japanese will tell you, sometimes it's not a dip. The most recent experience we had in the U.S. was in 1973 and 1974. People who were investing during that time can tell you that it was not much fun at all. In those two years, the S&P 500 lost 14% the first, and 26% the second. For those who were investing, it was the market equivalent of water torture, with people who believed that the market would rebound being slowly shaken from their confidence. Imagine, 24 months of consistent dropping in market value, with no relief whatsoever. Each day the market would drop a little more, with not much change in volume. No news helped, and no news really seemed to hurt that much, either. Just a slow downward trend for everything.

Could you endure it? Are you confident enough in the underlying business of the companies you hold that a long psychology-breaking bear market would not break you? We've seen some real despair come across the Fool discussion boards in the last month, but we've also seen some defiant bullish buying on the dips. But do you have the fortitude to buy on a dip for any company and not have it move back up for a two-year (or longer) period? Or would you eventually go running from the markets entirely. Very normal, very smart people gave up on the market in 1974 after a year- long bear market, completely disgusted with the concept of holding equities.

The S&P performance in 1975? 37% gain. The cardinal rule is that good companies executing their business models well in growing marketplaces will always endure a downturn in investor psychology. It's hard to fight superior earnings over the long term.

A closing note: Last Wednesday I wrote about the concept of trading using a retirement account. It was pointed out to me by many Fools that I did not discuss Roth IRA's, which are funded with post-tax dollars, but not taxed after that. Too right. Roth IRA's, in fact, add one more benefit to trading in a tax-free setting, and as such are an even smarter forum than other tax-free or tax-deferred vehicles. Still, just because it's smarter does not make it smart, necessarily. With a Roth IRA you still get no tax advantage from investing losses, and the same warnings apply that you should remember that this is money you have specifically set aside for some event later in life (retirement, kid's college, etc.). Still, thanks to all of you who pointed out the omission.

Fool on!

Bill Mann, TMFOtter on the Fool Discussion Boards