After 11 years, the bears are finally coming out of hibernation.
The Dow Jones Industrial Average lost 8% on Thursday morning, officially entering a bear market, which is defined as a decline of 20% or more from a recent high. Just a month ago, the Dow was at its all-time peak.
The S&P 500 wasn't far behind, trading 24% below its record just three weeks ago, while the tech-heavy Nasdaq was down 19% in the same span of time.
It's clear why investors are suddenly rattled. The novel coronavirus outbreak has spread from China around the world, forcing Italy into a lockdown, and disrupting daily life in the U.S. as well as much of the world. Festivals and conferences have been cancelled or put on hold, and sports fans are being told to stay home (games will be played in empty arenas). Americans are cancelling trips and working from home in order to avoid exposure to the virus.
Times like these can be nerve-racking for investors, who are jittery as their portfolios suddenly shrink and are wondering if an extended crash is in the offing. That's why it's an especially good time to consider the timeless wisdom of Warren Buffett , the Berkshire Hathaway (BRK.A 0.04%) (BRK.B 0.30%) CEO who's generally regarded as the greatest investor of all-time. At 89 years old, Buffett's seen it all in his investing career, and he's been generous about doling out advice along the way. Though the Oracle of Omaha has no formal guide for how to behave during a bear market, based on his writings and investing principles, we can put together a few of his investign rules and pieces of advice that would be worth heeding at times like these.
Warren Buffett. Image source: Motley Fool.
1. "Be greedy when others are fearful"
Perhaps Buffett's best known quote, the wisdom of this aphorism is in its simplicity. Buffett knows the best way to invest is to zig when others zag.
Now, of course, investors are probably more fearful now than they've been in a decade. There may be good reason for those fears, but a number of stocks have already lost more than half of their value, setting up potential bargains as investors are selling for near-term concerns. While the coronavirus could hammer the economy over the next few months and even lead to a recession, the long-term risk of the virus seems almost zero. Buffett is a famous cheerleader of the American economy and knows that the stock market has survived past crises including the 1919 Spanish Flu epidemic, the Great Depression, World War II, 9/11, and the 2008 financial crisis among others.
By this time next year, events like South by Southwest and the Coachella Music Festival will be almost certainly held as normal. Americans will return to their usual routines, doing things like that they're currently hesitant to do like taking vacations and eating out. Life will eventually return to normal.
2. Keep some dry powder ready
In recent years, Buffett has lamented the high valuations of stocks and privately held companies and told investors he's been unable to find well-priced companies worth buying. Berkshire's last major acquisition came in 2015 with its $32 billion purchase of Precision Castparts.
As a result, Berkshire is now sitting on roughly $125 billion in cash and short-term investments that can be readily deployed as bargains emerge on the market. You can't be greedy when others are fearful, after all, if you don't have any money to invest. Buffett capitalized similarly during the financial crisis when he had about $38 billion in cash and made big, well-timed investments in Goldman Sachs and Bank of America. During September and October of 2008, he made $15 billion in investments.
The Oracle of Omaha also likes to say, "Only when the tide goes do you see who's swimming naked." With more than $100 billion in cash to work with, you can be assured Buffett will never be caught investing with his pants down.
3. Invest for the long term
Another well-known Buffett quote is, "Our favorite holding period is forever." Buffett thinks of owning stocks as owning businesses. He's not interested in trading paper to make a quick buck. He's looking for lasting companies that will grow over decades, compounding their returns.
In a bear market, investors need to think similarly. One rule of thumb with buying stocks is not to invest any money that you plan to use in the next ten years. That's because a shock like the coronavirus can wipe out short-term gains, but over the long term the stock market has demonstrated an unmatched ability to deliver meaningful capital appreciation. Historically, the S&P 500 has returned about 10% annually, and that includes several bear markets, recessions, and other crises and black swan events.
4. Buy stocks that can withstand this kind of shock
It's no secret what kind of stocks Buffett likes. He prefers reliably profitable companies with strong balance sheets and sustainable competitive advantages, which he calls economic moats. Buffett is a conservative value investor, and he wants stocks that will deliver predictable returns. For instance, he's long been a fan of insurance companies as Berkshire owns a number of them, including GEICO. Americans need auto insurance even in tough times, and those premiums give Berkshire a steady cash flow to invest in stocks. Buffett also likes enduring consumer brands like Coca-Cola, and more recently, Apple. Coca-Cola has been a leader in beverages for a century, not just because of its well-known brands but also because of its global distribution network. Apple, meanwhile, has built an ecosystem in consumer electronics that will be difficult to dislodge. Both companies are highly profitable.
As an eternal optimist about the American economy and the stock market, Buffett would likely remind investors that for net buyers of stocks, a bear market is a good thing as stocks become cheaper. Though it can be scary to see your investments in freefall, especially amid the broader uncertainty and health scare around the coronavirus, it's worth remembering Buffett's thoughts on the current situation.
In a recent CNBC interview, the Berkshire chief said, "The real question is: Has the 10-year or 20-year outlook for American businesses changed in the last 24 hours or 48 hours?" Despite the uncertainty around the coronavirus, Buffett, like most investors out there I think, would answer with resounding "no".
