During this past bull market, one of the criticisms that I often heard of us at the Fool is "you've never been through a bear market." A friend of mine mentioned this to me one day and I was rather mystified. What can you learn in a bear market that you can't learn in a bull market? As the stock market dropped in 2000, I saw more of what he meant. Here are the eight lessons that I've learned or have been reminded of again:
- Never be invested in more companies than you can reasonably track. A bear market comes about from unfavorable conditions or even unfavorable investor sentiment. If you have too many company stocks, you might not be able to track what each company is doing effectively. This is true in a bull market, too, but it won't likely hurt as much when most stocks are rising.
- Bad news can come in droves for a company. Once the first bad news is released (an earnings shortfall, too much inventory, or uncollected receivables, for example) cautiously expect more weak news down the pipeline. Frequently, bad news is a domino effect, rather than a one-time event.
- Good news can be interpreted as bad news. Earnings might beat expectations, but some analyst will whisper that next quarter might not be as strong. Don't be too shocked as you watch the stock drop on good news in a bad market.
- All those young stocks that everybody was thrilled about in the bull market are likely to tank harder than most in a bear market. High P/E multiples, unproven business plans, and mounting losses are not a formula for success.
- Pay close attention to what the news actually is -- don't panic and sell your good companies. Sure, you might sidestep some decline; however, by being out of your best investments, you're likely to miss the bounce back up, too. And, there are tax implications when selling, as well.
- Don't "average down" when a stock is falling due to unsure and weakened business results that are not likely to change anytime soon, such that you question the company's future in any way. Remember what can happen with unexpected bad news. More weak results could be coming, and the decline might continue.
- Be aware that the Hysteria Index works both ways. People can get too excited about making money and push a stock value too high. They can also panic and push a stock value too low. Know your companies well, so that you don't panic when the Hysteria Index rises. Make sure that you use your Believe-O-Meter before you make any decisions.
- Forget about people who forecast the bear market is over, or who claim to know how much farther it will fall. No one really knows what the market will do. A rise one day does not signal the "end of the bear market." Timing the market is and has always been a futile effort.
Actually, most of these lessons apply quite well for a bull market, too. What makes things different in a bull market is that you can make a lot of mistakes and still make money. Conversely, in a bear market you can lose money (at least on paper) even without making mistakes. However, whenever you make a real mistake in a bear market, the amount of money that you'll likely lose is often exaggerated. So, there are valuable lessons to be learned in a bear market. The lessons seem to be ones of common sense.
What lessons have you learned? Share them on the Drip Basics board.