Investors love bull markets. A bull market means the stock market is rising, which is what stock investing is all about, right?
That's a bit simplistic, and there are reasons why investors should embrace bear markets when prices aren't rising so quickly too. Here's why.
The advantages of a bull market
One of the primary purposes of investing is to grow your wealth. However, success in investing usually is the result of remaining invested over a long period of time. Stocks that appreciate thousands of percentage points -- or more -- do so over long periods, not overnight, and most definitely not in one year. However, most of their growth happens during bull markets, when the market is optimistic and everyone is buying.
The downside of a bull market is that valuations can become very high quickly, constraining buying opportunities. Eventually stock prices fall back, but great stocks rarely lose all of their gains. Even when they lose a massive amount, they typically gain it back, and more, when a bull market returns.
The advantages of a bear market
There are varying definitions of a bear market, but one of the more standard ones is when the market decreases 20% from its previous high. It doesn't get back to a bull market until it surpasses its previous high. Last year we entered a bear market, and although the S&P 500 is up 12% this year and has been even higher, we are still officially in a bear market. You can see from this chart when the market began to climb after crashing in 2020 and stayed elevated until last year.
When stocks are down in a bear market, that's the time to buy. One of Warren Buffett's most famous quotes is "We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful." That's because when others are greedy, prices go up and often hit unsustainable levels. Drops are almost inevitable. Bear markets, when valuations deflate, correct prices and are prime stocking up opportunities.
No one likes to see the value of their portfolios decline, but bear markets provide a window to leverage the decreases and maximize opportunities.
Use both to your advantage
There are many different approaches to investing. One of them is a "set and forget" mentality. If you evaluate a company and determine that it's a worthwhile investment, you can buy the stock and more or less move on for decades. While this could result in some losses, it also shields you from the anxiety and fear that could accompany frequent or daily stock checks. There are bound to be ups and downs, bull and bear markets, black swan events and more throughout your investing journey. Great businesses will weather all kinds of storms and reward you eventually.
Image source: Getty Images.
Even if you take a more hands-on investing approach, where you buy and sell more regularly, you'll do your best investing when you make your decisions based on the company itself and not on external factors. Instead of ignoring the external environment, you can use it to your advantage by leaning into what the market can provide for you. In bear markets, it will be buying great stocks at low prices. That is likely to require being able to see the bigger picture. Some examples of excellent stocks at low prices, but with excellent free cash flow generated by the underlying business, to buy today are Home Depot, which is trading at a valuation of 18 times trailing 12-month earnings, or close to a 3-year low, and Chipotle Mexican Grill, which is trading at a price-to-earnings ratio of 45, or near half its five-year average.
CMG PE Ratio data by YCharts.
Once you've identified the top stocks for your portfolio, part of the process is ignoring the noise in the background. What you don't want to do is panic sell when prices go down. It doesn't matter if we're in a bear market or a bull market; hold on to great stocks through thick and thin, and you're likely to come out on top.
