What History Says About Investing in Bear Markets

Humorist and writer Terry Pratchett said, "This isn't life in the fast lane, it's life in the oncoming traffic." That's a fair description of what investors are feeling right now, thanks to a global pandemic that's sent markets into a tailspin.

Unfortunately, there's no easy exit route from this crazy highway. You could sell your investments, but then you lock in losses and risk missing the recovery. The safest bet is to ride out the turbulence. Admittedly, that takes enormous fortitude when everyone else, it seems, can't sell their stocks and mutual funds fast enough.

Image source: Getty Images.

It should strengthen your resolve to remember that all of this has happened before. Yes, COVID-19 is new -- but wild stock market volatility is not. There've been plenty of steep market downturns, and we've recovered from every single one. Here's a look at three big bear markets, and the recoveries that followed, over the last 50 years.

Inflation and oil crises: 1973-1974

Between January 1973 and December 1974, the S&P (S&P) lost 48% of its value. The Dow Jones Industrial Average (DJIA) suffered equally, showing a 46% drop over the same time period.

Underlying factors included out-of-control inflation and an oil crisis. In the summer of 1971, President Nixon made some bold moves to address inflation, including ending the convertibility of dollars into gold and implementing wage and price controls. In January 1973, he lifted those wage and price controls, and inflation spiked almost immediately. Then, in October, several Arab nations stopped exporting oil to the U.S. By the end of the year, inflation had risen to 8.8% and America was being pinched by a gas shortage. The markets floundered for another 12 months.

While inflation would continue to affect the economy for the rest of the decade, the market rebounded in 1975 and 1976. In those two years, the S&P showed gains of 31.55% and 19.15%, respectively. 1977 brought another market correction, with the S&P dipping 11.5%. Then, investors enjoyed three consecutive years of gains, including 25.77% growth in 1980.

The table below shows S&P performance from 1972 to 1980.

Table Data Source: Macrotrends.net

Dot-com crash: 2000-2002

The S&P and the tech-focused NASDAQ index showed three years of double-digit losses from 2000 to 2002. The DJIA faired a little better in that same time period, but still showed declines in all three years.

It was called the dot-com crash, because it followed a period of extreme excitement about the newly commercialized internet. Both novice and seasoned investors scrambled to own a piece of this technology space. Hundreds of internet companies went public and tech stock prices rose like crazy, untethered from traditional valuation metrics like price-to-earnings ratio and cash flow. Eventually, the tech shops started to run out of money. That's when investors realized valuations were too high and bailed out.

After an 85.59% increase in 1999, the NASDAQ fell 39.39% in 2000. Two years of losses followed, but then the tech index exploded with a 50% gain in 2003. The table below shows the returns of the NASDAQ, S&P, and DJIA from 1999 to 2007.

Table Data Source: Macrotrends.net

The Great Recession: 2007-2009

Between October 2007 and February 2009, the DJIA fell 50%, from 17,245.35 to 8609.71. That included a 777.68-point freefall on Sept. 29, 2008, which was the largest point drop in history until 2018.

Aggressive activity in the housing market had set the stage. Banks and financial institutions were scooping up mortgage-backed securities (MBS), considered to be safe investments with good yields. All of that MBS demand, unfortunately, drove lenders to write loans with a decreasing regard for underlying property value or the borrower's ability to pay. And because it was so easy to get a mortgage, more people bought homes, driving home values up.

Eventually, the housing market slowed down and home values began to slip. The shift left borrowers over-extended and lenders undercollateralized. MBS lost value, and the financial institutions holding them were suddenly unstable. Lehman Brothers declared bankruptcy, and other institutions had to be bailed out by the federal government.

If you remember those days, it felt like the world was, very slowly, ending. But the market did make some quick, early moves toward recovery. From a low point of 8609.71, the DJIA climbed back up to 13,067.22 in 14 months. It would eclipse its 2007 peak in November 2013, and then continue on to show gains through 2017.

The table below shows the DJIA's performance from 2006 to 2014.

Table Data Source: Macrotrends.net

Post-bear market gains can happen fast

In the throes of market volatility, it definitely feels like you're dodging cars -- or semis -- on a crowded highway. But if you're still in the market today, stay there. As history tells it, early waves of recovery happen fast. You don't want to miss them.