Oil seems to hit new highs every week. The bleak news from the housing market continues unabated. Layoffs are on the rise in many industries. GM
Companies that thrive on discretionary spending -- from java maker Starbucks
Economists and market pundits are telling every reporter who will listen that a recession may be looming just around the corner. Headlines everywhere scream that disaster is imminent.
And the investors who make up the stock market have been reading those headlines. As of last Friday's close, the S&P 500 was up a paltry 3.3% for 2007, almost 10% off of its high for the year -- and the trend is downward.
Is the bear upon us?
Ursine identification guide
It's hard to say for sure. Bear markets are like obscenity -- they're hard to define, but most people know one when they see one (or at least they think they do). A common yardstick is a 20% decline in a major market index over a 12-month period, accompanied by widespread pessimism. The pessimism is key to a bear market's nature. If people aren't throwing in the towel, it's not really a bear.
Contrast that with a market correction -- generally, a quick drop followed by a rally. Corrections are startling, and they can be scary, but they don't lead to a broad feeling that things are hopeless, that there's no money to be made in stocks. And unlike the fast break of a correction, a bear market is generally a long, slow grind downward. If you were invested in stocks during 2001-2002, you know what I'm talking about.
Out of hibernation?
So is this a bear market? Even filtering for the media's penchant for pessimism -- some of those pundits I mentioned have predicted 17 out of the last three bear markets -- the market's prospects are looking more grim than they have in some time. But here's the thing: You can't really tell if it's a bear market until you're well into it; or, sometimes, until it's over. And meanwhile, bear markets tend to follow a somewhat predictable pattern: They slowly grind downward, until they don't. And the early stages of the recovery are often sharply upward.
That's what makes trying to time a bear market's bottom such a tricky business. If you're even a little late, you can miss a lot of upside.
Staying out of trouble
Wall Street pros have played around with various bear market timing indicators for years, without a lot of success. These indicators generally try to measure sentiment: how pessimistic market participants (or would-be participants) are about the market's prospects. The idea is to find the moment when the last of the optimists has thrown in the towel. That's supposedly the point at which the market will turn and start to rise.
If you're interested in that line of thinking, I suggest you read market guru Ken Fisher's book The Only Three Questions That Count for fuller discussion. For most of us, though, that kind of market timing is neither reasonable nor particularly smart.
Here's what long-term investors should be thinking about instead:
- Don't panic. Bear markets are natural and inevitable. If you're a long-term investor, don't let paper losses spook you into selling otherwise-solid investments. Remember that paper losses don't become real losses until you sell. Things may look ugly when you log in to your brokerage account, but if you've got 10, 20, or 30 years to go until retirement, it's just a passing storm -- don't let it sink you.
- Remember Buffett. One of Warren Buffett's famous bits of advice is to "Be fearful when others are greedy, and greedy when others are fearful." The grinding low points of a bear market are a great time to be greedy, to invest new money in solid long-term prospects while they're on sale. And don't worry if they go lower after you buy. If they're solid, they'll more than recover.
Finally, when you go bargain hunting, spend extra time looking at the hardest-hit sectors. Right now, there are housing and mortgage stocks that have been absolutely clobbered by investor pessimism and panic, but which will see huge gains in coming years. Of course, there are others that might not survive the current crisis. If you can do the research and tell which stocks are which, handsome returns could result. But don't bet the farm on just one or two -- any long-term portfolio should stay diversified for best results.
Fool contributor John Rosevear loves perpetual pessimist Alan Abelson's column in Barron's, but sometimes wonders what it would be like if Mr. Abelson got himself some Prozac. John does not own any of the stocks mentioned in this article. Wal-Mart is an Inside Value recommendation. Starbucks is a Stock Advisor pick. The Motley Fool has a disclosure policy.