Investing in a Bear Market: Bear Traders & The Basics of Breakeven

The chart below shows the five largest bear markets since the 1960s
Above each bar is the date the bull market peaked
Below that, is the number of months it took for each bear market to trough
We do not believe anyone can time the market but, as shown in our research, the stock market is far more expensive than the peaks in October 2007 or August of 2000
The first bar shows that it only took 16 months to lose 51% of your money

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Market turns are difficult to time. Despite tik-toks to the contrary, we believe short term day trading is a path to poverty. Many investors have lost sight of the incredible amounts of time it takes to recover from sharp losses in bear markets.

Investments for Bear Markets

Our research team believes that some investors have forgotten that you can actually lose money in stocks. The bull market underway has been so extraordinary that it often feels like the books about the roaring 20s. We will publish a brief summary of a book that addresses the bull market in the 1920s shortly with the hope of inducing a modicum of prudence.

The bars in the chart below are identical to the previous one. We added the following information:

The number of months it took to breakeven from each of these bear market crashes
The market valuation right before the bear market crash began (red dot, right-hand scale)
The valuation of the market at the trough when it was finally safe again (green triangle, right-hand scale)

Let’s revisit the first bar. It shows that from the peak of the mortgage bubble in 2007 through the trough in 2009 the market lost 51% of your money. As noted above, that disaster took a quick 15 months. You can see, however, that if you invested $1 at the peak in 2007 and held on to the trough in 2009, it took 37 months and a rise in the market of 104% for you to simply break even.

That may seem tolerable with hindsight. But that means you spent over three years just trying to break even from catastrophic bear market losses assuming you held on. As noted in our research, while the market succumbs to speculative fads, we have advocated for buying high-quality firms at reasonable prices.

Look at the valuation statistics on that first bar. The bubble peaked in 2007 with the stock market valued at 1.6x price to sales. By the time the bear market was done, valuations had fallen to 0.8x.

Move one bar to the right. That is the peak to trough of the dot.com bubble. The market peaked at 2.3x sales and troughed at 1.3x sales. But it took a staggering 49 months for someone who bought at the peak to simply break even on a dollar.

Please note the red dot on the far right. That is the Price to Sales ratio of the S&P 500 today. At 3x sales the index is nearly 50% higher than in 2000. It would require nearly a 60% loss to hit the lows seen post the dot.com crash.

Our team does not post these bar charts with the intention of scaring anyone. We are simply wary that massive government spending, low rates and huge injections of liquidity by the Fed have generated what we believe is a bubble in certain equity prices. As we have documented in our many research notes on the topic, we believe the best opportunities are in stable, high-quality and reasonably priced companies.

One of the major benefits of the distortions we believe are underway in markets today is that when investors chase fads it often results in higher quality companies becoming relatively cheaper. We have made that case emphatically in both small caps and cheap stocks very recently.

Legendary investor Seth Klarman, also the author of the margin of safety book, noted that index funds become more popular during bull markets. We agree. He also noted that “Although indexing is predicated on efficient markets, the higher the percentage of all investors who index, the more inefficient the markets become as fewer and fewer investors would be performing fundamental analysis.”¹

Financial markets today seem to be driven off near-instant changes in perceptions around current and future interest rates. We cannot forecast such things but we do believe the S&P 500 and other indexes are expensive in aggregate. We believe the legions of day traders are an unfortunate sign of the times and a call for prudence.

Our team believes that traditional investing methods of reading annual reports and understanding fundamentals is one of the least practiced and, therefore, one of the easiest approaches to improve on market returns today. In our view, an investment strategy that is anchored in time tested and proven practices of buying quality at low valuations will likely outperform in the years ahead.

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FAQ

What Is a Bear Market?

There are many places that offer various and sundry definitions of what a bear market is. In our view the most important thing to remember is that nobody can time markets. People running around asking are we in a bull or bear market? are apt to succumb to the emotions of fear and greed at exactly the wrong moments. KCR offers tools to help investors keep disciplined asset allocation in bear markets and bull markets alike.

For a comprehensive list of our materials please visit our Subscription Page. We primarily serve institutions and financial advisors looking for simple but powerful tools to improve stock selection and portfolio construction.

SERVICES

As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade. If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you. KCR also offers a wide range of easy-to-use but sophisticated tools. Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias. L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.

ADDITIONAL READING

The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra reading for anyone seeking out more information related to the topics above.

SOURCES

¹ A Margin of Safety, Seth A. Klarman, page 51

Disclaimer

The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital, LLC – All rights reserved.

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