I'm a sucker for a good bear market, not because I enjoy the carnage, I don't. I enjoy it because by the time we all recognize it as a bear market, it's usually almost done and the prospect of finding good investments amongst the weak stock prices is like being a pirate looking for treasure. Or, Geraldo Rivera looking for Al Capone's vault.
You see, most bear markets, if you listen to the talking heads, are defined by a drop of 20% in a market average from its last top. The humorous thing about this is that once the market drops that 20%, the pundits get very serious and say "we're in a bear market. Grrrr." Fact is, it's almost exactly at the time they start growling that the bear is over and the bull starts anew. There are some exceptions to the 20% "rule" though. Seven to be exact. I counted seven bear markets that took the Dow Industrials down more than 30%.
Right now, we're in one of those exceptional bear markets. In mid-January of 2000, the Dow Jones Industrial Average was at 11,750. Last week, it hit 8062 at the worst level, which is a 31.38% decline. I decided to look at the Dow since the early days of this century. I know it's not the best market proxy, but it is instructive. I looked at weekly data for the Dow since 1915 to see how bad the bear markets were and how long they took to recover. Here is what I discovered:
- There have been seven bear markets since 1915, not including the one we're in now, where the Dow Industrials lost more than 30%. The average decline was 51.4%
- The average Dow P/E at the top of the market has been 20. The average P/E at the bottom has been 10. For this bear market, we started at a P/E of 23.6 and we stand now at 25.97 due to earnings that have declined faster than the market.
- The average dividend yield on the Dow Industrials at the top has been 3.25% The average dividend yield at the bottom has been 6.38%. This bear market started with the dividend yield at 1.43%. It's currently at 1.75%.
- The average bear market lasted 105 weeks, or just about two years. As of September 21, the current bear market is in its 84th week.
- The average amount of time it took the Dow to get back to where it was before the bear market started was 8.5 years.
Will this bear market conform to these average statistics? Unclear. Seven data points are too few for definitive conclusions, and any "average" -- including this one -- is made up of events subject to widely different circumstances, many different from today. World War I precipitated a bear market, where today we have a war scare long after the bear began. Tight Federal Reserve monetary policy may have turned the Crash of 1929 into the Great Depression, but today we have a Fed and chairman pumping liquidity into the system since January in an unprecedented way. The 1973-74 bear market "enjoyed" the unusual combination of the Vietnam War, Watergate, and the excessive valuations of the Nifty Fifty." Some say the 1987 "Crash" was caused by speculation in stock index futures and exotic ideas like "portfolio insurance." Our bear market was caused more by excessive valuations than poor Fed policy or world events.
So if we do compare our current bear to the former, what do we get? Here are my opinions about how this bear is the same or different from the other 30%-plus Dow plunges:
1. Some stocks may not see old tops for a long time, if ever. For those of you that think we're going to zoom right back up to the old highs anytime soon, we aren't. Any money you invested at or near the top is going to be non-productive money for a little while (see this recent column on the fact it may be a long while, or even never, for some Nasdaq high flyers). Your goal at this point should be to work towards committing new funds to the market on a regular basis so you achieve the averaging affects that our Drip Portfolio team talks about so much.
2. Dividend yields may increase. Is it different this time? Well, there's one major difference that we can focus on and that is Corporate America is much less focused on paying dividends than they ever have been in the past. So, the low dividend yield is less a result of high prices than it is low absolute dividends. Investors have bought into the "we're going to use all the retained earnings to grow" argument. In many ways, I think that's fine, and has served many companies like Microsoft
But there comes a time when shareholders are better off with the money in their pockets than they are with the company trying and failing to grow the top and bottom lines. I predict that we'll see a resurgence in the importance of dividend distribution. Investors are going to demand some yield with their growth, or they're just going to put their money someplace else, like bonds.
3. Prepare for the possibility of more pain. Looking at forward P/Es (current price divided by next year's earnings estimate), the average forward multiple for the Dow stocks is 18.34. At 18 times forward earnings, with little or no yield, especially in an environment where earnings are going down and not up, it's not irrational to think that there's still some pain to go on the Dow.
4. One company to look at. If you look closely, you'll see that most of the companies in the Dow have seen their earnings estimates for next year come down considerably. One company on the Dow that hasn't had much in the way of downward earnings revisions is Phillip Morris
5. Don't fight the Fed. The Fed has dropped rates nine times this year. This may be the most aggressively the Fed has ever lowered rates in such a short period of time. They are pumping cash into this market like there's no tomorrow. This kind of liquidity stance has always been good for equities. We have that going for us and if there is going to be a turnaround, it's this sort of aggressive monetary (and increasingly fiscal) policy that will bring us out of a tough time.
So, what should the average investor do? My advice is to prepare yourself mentally for the fact that the market may continue falling. Stay off margin. Add savings deliberately, over time, to get the benefit of dollar cost averaging in your index funds. And, if stocks scare you, there's nothing wrong with looking at some higher yielding corporate bonds that have solid investment grade ratings.
Markets like this create uncertainty and there's nothing wrong with admitting that you aren't sure what to do. If you want to talk to someone and get specific advice about your finances, you should check out TMF Money Advisor. You'll get specific, unbiased, and personal counsel from professional advisors. They won't try to sell you anything either.
And let's keep in touch on this bear. I think we'll all benefit from watching the valuations in this market and working together to figure out when might be a good time to head back in. One place for us to share our thoughts is the Communion of Bears discussion board.