3 Silver Linings of a Bear Market

Many Daily Cut readers will struggle with today’s optimistic message…

It’s easy to see why.

In the first six months of the year, the S&P 500 – our regular stand-in for the U.S. stock market – plunged 19.5%.

Since 1928, there have been only six worse first halves of a calendar year. These came during the Great Depression, the 1937 crash, during World War II, the 1970s bear market, the dot-com bust, and the 2008 crash.

And despite our predictions in these pages that we wouldn’t enter another “Crypto Winter” bear market… bitcoin (BTC) is down about 57% from its November high. Ethereum (ETH) is down 70% from its high the same month.

This has wiped out roughly $2 trillion from crypto investors’ net worth.

If you’re watching CNBC… or scrolling through Twitter… you’ve seen plenty of scary headlines. They’re not only about plunging markets… but also record inflation, war in Eastern Europe, and a looming recession.

But taking your cues from mainstream sources… and following the crowd out of quality assets… is a sure way to lose your shirt.

It’s scary seeing our portfolios shrink. But bear markets – falls of 20% or more from a peak – are normal.

Since 1928, the S&P 500 has had 27 bull markets. It’s also had 26 bear markets. On average, those bear markets have come roughly every three and a half years. We’re in one now.

And despite what you may think… they’re not all bad news for us as investors. So today, we’ll explore three silver linings to these regular downturns.

Silver Lining No. 1 – Quality assets go on sale

It sucks to see your stocks and cryptos fall.

But if you’re still regularly contributing to a 401(k) or an IRA, you can buy these assets at steep discounts to where they were trading six months ago.

And the cheaper you buy a stock or cryptocurrency for… the higher the profits will be when you sell.

That’s why the old-timers on Wall Street say you build real wealth during bear markets… not when the going is good.

Here’s colleague and former Wall Street trader Jason Bodner, who heads up our Outlier Investor advisory…

For my personal investment accounts, I like the model super-investor Warren Buffett follows. He advises, “Be fearful when others are greedy… and greedy when others are fearful.”

I take income from investments or businesses I own. I spend what I need to live on and deploy the rest into stocks when the market is falling.

In the short term, that means I have to sit with some losses. Over the long term, though, I pick up bargain shares of companies I believe in. That ramps up my returns when I sell.

Silver Lining No. 2 – Income investing becomes more profitable…

There are two possible sources of profit on any investment – return and yield.

Your return is the amount you gain or lose over time as the value of your investment changes.

Your yield is how much income that investment pays.

Take the dividend yield on stocks, for example.

If a company pays out a dividend of $3 a year to its shareholders… and its stock trades at $100… that’s a dividend yield of 3%.

If that stock plunges 50% to trade at $50… its yield doubles to 6%.

And as stock prices fall, companies tend to raise their dividend payments to keep shareholders on board.

This has caused the average dividend yield of the 500 stocks on the S&P 500 to grow from 1.3% at the start of the year to 1.7% today.

That’s not a huge jump. But 11 stocks in the index have doubled (100%+) their yields since the start of the year.

The same is true for bonds. Their prices have been falling lately. So their yields have been rising.

You can now pick up a yield of 2.9% on the 10-year Treasury note versus 1.4% year ago.

Silver Lining No. 3 – Investors’ time horizons shrink…

Many regular investors think Wall Street hotshots have an advantage over them.

In some ways, that’s true. Fund managers, for instance, can afford to spend hundreds of thousands of dollars on research and analytic tools. Most folks don’t have those kinds of budgets.

But as individual investors, we also have significant advantages over the pros.

One of them is the ability to choose longer time horizons.

Fund managers get scores on their quarterly performances. Their bonus payments are also linked to short-term performance metrics.

So when stocks and crypto tank, the pros get paranoid that their quarterly numbers will stink. And they sell out of quality assets… regardless of long-term potential.

This gives the rest of us an edge.

Instead of fretting about what will happen over the next quarter… we can focus on 10 years and invest accordingly.

You can’t know if the stock market will be up or down over the next quarter.

But you can be very confident it’ll be up over the next 10 years.

That what market history shows…

One study in Traders Magazine caught my eye.

It looked at annual returns for the S&P 500, with dividends reinvested, from 1926 to 2018. And it showed that investors saw annual losses in about a quarter of the years.

But over longer holding periods, the chances of losing money in stocks dropped dramatically.

With a 10-year holding period, your chance of losing money was just 5%.

And there wasn’t a single 20-year holding period when investors lost money.

In other words, it’s hard to predict short-term moves. But the longer your time horizons, the more confident you can be that you’ll profit.

And scooping up bargains – while other investors focus on the short term and flee – amps up your long-term gains.

Until tomorrow,

Chris Lowe
July 6, 2022