Bring on the Bears

Bear markets are a gift. Yet too many investors are reluctant to act. Most investors just don't understand the incredible resilience of equities.

This article is published with permission from InvestmentU.com.

Since March 2013, the Dow has hit numerous all-time highs. But on Dec. 20, it did something it had never done before. It hit an all-time high in inflation-adjusted terms.

The Dow has recovered from the Internet bubble, 9/11, the Enron scandal, the housing bubble and the global financial crisis.

Are we just lucky? Hardly. Most investors don’t understand the incredible resilience of equities.

Imagine, for instance, that you invested equal amounts in the U.S. stock market, the British stock market, the German stock market and the Japanese stock market on the eve of World War II.

Thirty years later the returns on your Japanese and German stocks were virtually the same as the performance of your American and British stocks, even though Japan and Germany suffered national devastation and near-total economic collapse. (For the full story, read Jeremy Siegel’s Stocks for the Long Run.)

How can this be? Well, all people have economic needs: food, shelter, clothing, health care and so on. Business owners, venture capitalists and public shareholders are motivated by rational self-interest to meet those needs.

The private sector promises that you can have anything you want if you just provide enough other people with what they want. What a beautiful system.

After the crisis

When the recent financial crisis hit, business managers took the appropriate actions. They laid off unnecessary personnel. They cut discretionary costs to the bone. They refinanced their debt at lower levels. It was clear that even a modest uptick in sales would cause net income to soar. And that’s exactly what has happened. Over the last four years, the companies that make up the S&P 500 have experienced record profits and record profit margins, as well as record profits as a percentage of GDP.

Just imagine if we had never experienced the two severe bear markets between March 2000 and October 2002 and between July 2007 and March 2009. If instead the Dow had merely eked out an annual return of a couple percent a year for the last 14 years, we wouldn’t have had all these terrific buying opportunities.

When stocks go on sale

Bear markets are a gift. Yet too many investors — nervous, afraid and cowed by the national media’s sensational coverage — are reluctant to act.

I’ve never understood this. If a sweater goes on sale, you buy it. If a bottle of wine goes on sale, you buy it. If a convertible goes on sale, you buy it. But if the markets go on sale, you rush to sell your stocks or sit on your hands?

In my former life as a money manager, I was amazed that the clients who refused to buy into one bear market also refused to buy into the next one and the one after that. Their decisions were emotional rather than rational. Unfortunately, emotions are almost always wrong.

If you want to make money, serious money, in the stock market, you have to be a rational optimist. Understand that the economy will expand and contract. Interest rates and inflation will rise and fall. Stocks will roar and then plunge. That’s just the way things are.

But go back to fundamentals. We all have economic needs. Businesses exist to fulfill them. (And innovate to create new ones.) Business owners and shareholders (that’s us), not to mention consumers, reap the rewards.

As President Harry Truman famously said, “The only thing new in the world is the history you don’t know.”

Alexander Green is the chief investment strategist at InvestmentU.com. See more articles by Alexander here.

The information contained in this article should not be construed as investment advice or as a solicitation to buy or sell any stock. Nothing published by Physician’s Money Digest should be considered personalized investment advice. Physician’s Money Digest, its writers and editors, and Intellisphere LLC and its employees are not responsible for errors and/or omissions.