It's been a dismal year for many investors. High inflation and rising interest rates have created a great deal of economic uncertainty, triggering a sharp decline in the stock market. In fact, the S&P 500 had its worst first half in more than five decades, falling 21% between January and June. That put the broad index in bear market territory for the seventh time since 1970.
The S&P 500 has since recouped some of its losses, but the bear market will not officially end until the index hits a new high. That may take a while. The S&P 500 last peaked about 210 days ago, but historical data shows that past bear markets have dragged on for an average of 391 days.
That being said, speculating on the duration and severity of a downturn is somewhat pointless. So here are three things smart investors do during bear markets.
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Peter Lynch: Stay invested through bear markets
Legendary investor Peter Lynch ran the Magellan Fund at Fidelity for 13 years. During that time, despite weathering two bear markets, Lynch earned an annualized return of 29.2%, more than doubling the return of the S&P 500. That success can be attributed in part to his level-headed mindset. Lynch once said, "The key to making money in stocks is not to get scared out of them."
Bear markets are scary. Watching your portfolio shrink during a downturn is a gut-wrenching experience, and that type of stress often leads to irrational decisions. For instance, you may tell yourself that you'll temporarily sell your stocks and buy back in when things turn around. But timing the market is impossible, and if you try to dip in and out of stocks, there is a good chance your portfolio will underperform in the long run.
The best course of action -- assuming you've done the research and have conviction in the underlying businesses -- is to hold your stocks through market volatility. In doing so, you position yourself to realize the maximum benefit when the market inevitably rebounds.
Shelby Davis: Bear markets are buying opportunities
Shelby Davis is not as well known as the likes of Warren Buffett or Peter Lynch, but his story is no less inspiring. In 1947, when he was 38 years old, Davis put $50,000 into the stock market. By the time 1994 rolled around -- eight bear markets later -- he had made the Forbes 400 list and his portfolio was worth $900 million. That success can be attributed in part to his ability to spot buying opportunities. Davis once said, "You make most of your money in a bear market, you just don't realize it at the time."
It is human nature to be overly optimistic in good times and overly pessimistic in bad times. As a result, stocks tend to reach exorbitant valuations during bull markets, and they tend to trade at very cheap valuations during bear markets. That means downturns are an especially good time to buy stocks.
Warren Buffett: Not all beaten-down stocks are worth buying
Warren Buffet is widely recognized as one of the greatest investors of our time, and that reputation is well deserved. Under his leadership, Berkshire Hathaway shareholders saw an annualized return of 20.1% between 1965 and 2021, and much of that success is due to Buffett and his ability to pick winning investments.
Buffett once summarized his strategy by saying, "In business, I look for economic castles protected by unbreachable moats." In other words, businesses that have a sustainable competitive advantage tend to make great long-term investments. Apple's brand authority in consumer electronics, Amazon's intellectual property in cloud computing, and Bank of America's scale as a financial services provider are all good examples, and Buffett owns all three stocks through Berkshire Hathaway.
To summarize, bear markets are a good time to buy stocks, but not every beaten-down stock is worth buying. Investors should look for businesses with strong prospects for future growth and some type of competitive differentiation.
