due to their lack of knowledge of how long they typically last. Also, they'll be led astray by the media hype and because a stock has gone down a decent amount (not knowing that its likely got MUCH further to go) as the overall market influences their stock downward.
So, I wanted to take a look back at the major bear markets from 1980-present. Over that time, there have been a number of "bear markets" in stocks (red boxed areas on the chart below) along with several severe market corrections too.
I've found that the optimism is so high, near market tops that you can't get many people to sell out of their overvalued stocks because they get jaded by the media hype and their own greed takes over. So of course, when the downtrend starts, they just think its a pullback within the overall downtrend (because all the rest of the pullbacks they've experienced have been that way).
And by the time that they realize that "stocks aren't coming back" for a long while, they're already deep into the downtrend, which wiped away all of their profits and put them deep into the red. Then they sell out en masse near the market's bottom because they "feel" that stocks are never going to turn back upward. And yet, it's usually not long after that...that stocks begin their ascent once again.
But during this whole process, those that do have the sense enough to sell out of their overly-hype and overvalued stocks tend to be quick to jump back in. After all, they think that since their stocks have pulled back 5%, 10% or 15% that surely the bottom must be in.
But what they don't realize is that it takes TIME to wring out the overvaluation in a stock. AND stocks don't just go from a state of overvaluation to a state of fair valuation and halt their decline. In a perfect world, it would be that way...and stocks would never get to a point of undervaluation.
However, in reality, stocks go from a state of overvaluation and pass right through a realistic valuation (fair value for the stock) and cut right through that level on its way to deep values. Why? It's because just as the greed factor caused investors to overvalue a company and justify (in their minds) why it was worth it, they also overly pummel a stock, due to the fear that's gripped them that makes them "feel" like stocks are never coming back again. So, these emotionally-led decisions lead to points of overvaluation and undervaluation.
(Click on the chart above to enlarge it).
But how long does it take for the market to go from a point of overvaluation to a point of undervaluation? You'll see from the chart above, that there's no set time...but yet we can tell it takes TIME. And a bear market in stocks usually lasts MUCH longer than you'd ever think it would.
Some bear market downtrends in stocks are the scare-the-pants-off-of-you, quick types...like we saw in 1987 and again in 1990. Those are rarer and these usually last mere months to a year.
But then there's what I call the death-by-a-thousand-cuts downtrends which take a very long time to play out. More recent examples of these are the bear markets of 2000 and 2008. Their drops are painful, percentage wise (with drops sometimes up to 40-60%) but that take a LONG time (2-3 years or more).
So, what I've found is that those investors who are willing to hop back in are willing to hop back in WAY too quickly because they feel the recent drop causes the stock to trade at a value (even though it's not) or because the stock has dropped for weeks to a few months.
But I've found that when a bear market starts, there's no need in investing any money in the broader market until that bear market downtrend has been going for at least 6-9 months...and that would only be if it's one of those steep, quicker ones like we saw in 1987 or 1990.
In many bear markets, we can let a year or two pass before re-investing capital into the market. And there's the real test for the typical investor. They're so trigger-happy to invest, that it becomes more important for them to be fully invested (because they have the "fear of missing out", than it does to use their head and look at fundamental valuations to see if the overall market is trading at a value yet or not (by assessing the average P/E of the S&P 500). Here's a site you can bookmark that helps you to visualize the average P/E of the S&P 500. http://www.multpl.com/ (Make sure you've chosen "Chart" rather than "Table").
The stock market isn't trading at a value until its somewhere in the 6-14 P/E range. Anything above that and you're simply at a state of fair valuation or overvaluation.
You'll never know ahead of time how deep the bear market will go and how cheap it will take the average P/E. The P/E doesn't always go down to 6-8 before it turns around. Sometimes its higher than that. Sometimes its lower.
So, what you do is you divide your investable capital into three equal dollar amounts. You invest your first amount when the stock market enters the value P/E zone. And you invest your 2nd and 3rd rounds if there are further significant drops that take the average P/E materially lower.
This won't "call a bottom" because no one can do that. But what it does is...it's gets your average breakeven price much closer to the bottom than it otherwise would if you'd gone "all in" at a certain level. It gets you profitable quicker and its gets you a higher overall return than the "all in" at one level approach (that most novice investors use).
As you can see, it's been a long time since we've had a bear market in stocks and its one reason why I'm writing this to you now...because we're overdue for one, time wise. But as you look at the link above, you'll also see that the average P/E is now at levels where we've had former market crashes. (The two spikes much higher in 2000 and 2008 are where earnings collapsed even faster than prices essentially giving false P/E readings).
On average, there's a recession and bear market in stocks around the seven-year mark. Remember, that's an average. So some happen sooner while others happen later. Well, I point that out now because we're at the NINE-year mark, which means we're pushing it. And the longer it's been since the last recession, you can't get many people to believe the next one's going to happen anytime soon. They just eternally believe (being gullible), that what has happened will simply be what continues to happen...and they can't see a day when that would ever change. That goes for bull markets (when they don't see a day when they'd ever end...and they feel they have financial media hype to back up their views). And it goes for bear markets (where they don't see a day where stocks would ever turn back up again...and they usually have the financial media they can thank for that fear-based, emotionally-led thought process as well).
To summarize: Bear markets drop stocks more, percentage wise, than you'd normally think. They tend to last longer than you'd think. Investors mess up by investing too quickly. And they eventually mess up by never investing again at all, after a bear market. They also err in that they're itching to deploy cash. They "feel" better about being fully invested for the FOMO (fear of missing out) rather than rationally investing when it makes fundamental sense to do so. They also mess up by going "all in" with their money rather than by dividing their money into three equal dollar batches and by averaging down over time, after significant drops in stocks (and after the stock market starts to have a P/E that's in the value zone).
By keeping this in mind, you can avoid all of these common investor mistakes and end up with a market-beating return as you remain Logical Investors while the masses continue to be emotional investors.