An increasing number of participants are entering the world of investments with little or no experience in real bear market conditions. This post is for them, primarily for stock investors, but to some extent, it concerns almost everyone holding long-term bonds, precious metals, or any investment fund. For those who believe that this post does not concern them because their fund manager (investment advisor, guru friend, etc.) will take care of everything, I would recommend reading a book about the history of hedge funds. It’s a costly mistake to assume that someone else will handle it for you.
The situation is this: if you haven’t experienced a bear market as an active investor yet, you don’t know much about yourself, your decisions, and the correctness of your investment system. The primary role of bear markets in the financial ecosystem is to induce a wealth transfer between experienced and inexperienced participants. You can probably guess the direction of this transfer. The money of many small investors moves into the hands of a few large players. From the ecosystem’s perspective, this has a positive effect, as strong, experienced investors replace panicky, unpredictable players, thus increasing system stability. However, it may not console you if you end up on the losing side. It’s essential to understand that a bear market isn’t the failure of the bull market but has an important, functional role in the entire system’s survival.
The bear market could arrive next week or in five years. The probability is small for both scenarios, but it’s more likely somewhere in between. It’s not about the timing; it’s about the fact that it’s guaranteed to arrive. For beginners, I suggest bookmarking this post and rereading it quarterly until the bear market arrives. If you do this, you’ll be very grateful for this advice.
What does the bear market know that you don’t? It knows how to completely fool you. Its ‘goal’ is for you to be in a tremendous position with a wide grin by the time it arrives. I repeat, you will likely have many more shares than you had at the beginning of the bull market, even more than you held on average during the bull market. And you’ll be extremely happy.
How will it do that? I can’t tell you precisely because I don’t have the ability to see the future, but we know its past methods.
For example, it starts an endless correction-free uptrend, producing ever higher returns. At first, you’ll smile under your mustache, thinking you’re outsmarting it, that you’re not like others. But time passes, and you start feeling more uncomfortable. You’re waiting for the correction, but it keeps getting smaller. You’re impatiently watching the returns you missed during this time. The taxi driver next door reports how much he’s made in the XYZ investment fund, and they’re going on a luxurious vacation. Then, one beautiful spring day, you can’t take it anymore, and you pour your money in. First cautiously, a little bit, and then you realize how much you ‘lost’ by not investing it all. You put in all the money you’d been hoarding, and you’re delighted. Amen, let the bear market begin.
Now you think this can’t happen to you. You’ve read many such foolish stories. You know that when they talk about stocks at cocktail parties, it’s time to exit. Why are you reading such clichéd nonsense? Find some cute cat pictures; why continue reading? But if you keep reading, you’ll find out what a fool you are, just like everyone else.
What is this masochism all about? Okay, let me tell you a story. There’s a man named Stanley Druckenmiller. His name might not be as well-known as the Hungarian-born George Soros, but that’s because Soros’s marketing is orders of magnitude better. Druckenmiller managed the Soros Quantum Fund, producing annual returns of 30% during its brightest days. The famous English pound short idea was Druckenmiller’s, with Soros’s role ‘merely’ being to increase the position size manyfold. Druckenmiller took over Quantum in 1988 (presumably, he had some experience before that), produced outstanding returns for 12 years, and left in 2000. He left because he went on a tech company shopping spree at the peak of the technology bubble (literally weeks before the peak), resulting in over 20% losses for Quantum in the first half of 2000. In retrospect, he knew that he shouldn’t have done it (he had some small prior short attempts in technology but on a much smaller scale). He watched the ascent helplessly until it reached the point where he couldn’t bear it any longer and started buying in large quantities.
This story should humble every participant. If one of the standout investors of the last century, the best-performing fund manager, could go on a tech shopping spree at the peak of the technology bubble, you’ll be able to do it too.
The market is much more cunning than just trying to achieve its primary goal using one scheme. Are you prepared for the version mentioned above? Don’t worry; there’s another. For example, it suddenly drops significantly. You panic and sell. It gradually starts to rise again until you’re convinced to buy back in. Then it falls again. If you panic and sell, the cycle starts over. But after a while, you’ll become familiar with the market; you won’t fall for these unexpected drops. In fact, you buy because it’s cheap. In full position, you’ll wait for the rebound with a wide grin. So, the bear market can begin…
Believe me; you won’t escape it. This is the essence of the market. It cannot come unless the fools are trapped. Look around; how many fools do you see? Then you’ll be one. You have only one way to avoid the trap: you can’t make decisions. More precisely, you have to do the same thing you did during the bull market. You can’t change anything. If you held the world’s simplest portfolio, rebalancing annually, you can only do that. But use a Permanent Portfolio or a thousand other options if you like, just stick to your initial plan. Rebalance at the end of the year; if you have money, buy something according to the given proportions, and that’s it. No extra steps, no overthinking.
Don’t use ETFs? No problem. Suppose you held 5-6 investment funds in equal proportions, occasionally buying one of them. You can do precisely the same during the bear market. If you have a momentum system, follow its rules; if it’s valuation-based, stick with it. The point is, nothing should change. This is where it will be determined whether you will become an investor or just another person who will complain about the crazy markets for the rest of your life. If you can carry out what you’ve been doing without changes, you’ve won the game. If you can’t, then your system was wrong or not suitable for you. As I mentioned in the introduction, the primary function of bear markets is to weed out the faulty systems. On a bull market, not much matters. Are you generating too many costs? It doesn’t matter; there will still be returns. Are you jumping mindlessly from one investment to another? No problem; everything will rise. Are you making wrong decisions, incurring losses? No big deal, you just have to sit it out. As long as you exist in a bull market, nothing will be revealed about you or the system you’ve been using. The bear market always gives the judgment. Mercilessly.
It’s essential to understand that you can’t run from the bear market. It’s an illusion to think that others will solve it for you. No one can handle your pain. No one can take it off your shoulders. It’s your money, your responsibility.
You can’t run away. If, after reading just this post, you’re frightened and think it’s better to get out of the market now and wait for the next bear market to come down before returning, it’s an excellent plan! Hahaha! It seems you didn’t understand anything from this post. I guarantee that, with your portfolio full of stocks and other risky assets, you’ll plunge into the bear’s arms with a grin. There’s no escape, no shifting of responsibility; there’s only one path. You carry out your system during the bear market, or you leave now and forever.
Think it through carefully.
Dominic Feron 