With stocks entering a bear market at their fastest pace ever, many people are asking, what’s next. Though the future is always unknown, we can look back at history for clues.
Here are three things to keep in mind about being in a bear market:
1. Stocks tend to recover before the economy.
Trying to time market peaks and bottoms by recession patterns does not work. The market usually goes down in anticipation of a recession and can start to recover in the middle of a recession. Why? Because stocks are forward looking.
More important than how a company is doing right now is how the company is looking 12 months from now. If there is light at the end of the tunnel, we can see a rebound in stock prices–we don’t necessarily have to be out of the tunnel.
No one knows where the market will ultimately find a bottom, and it seems likely that we are in the beginning of a recession. Especially after such a big (and fast) decline in the stock market, these seem like reasons to sell your stocks. But stocks typically rise starting 3-6 months before the economy recovers. We may already be in that window. Selling now might be setting yourself up for regret later.
2. Stocks tend to do well after corrections.
Markets have delivered strong returns after bear markets—even as quickly as one year after the low. Investors who hang in during the tough times have historically been rewarded with higher than average returns going forward.
There’s a saying that stocks take the escalator up and the elevator down. This statement is especially true today. But bear market recoveries can be equally as fast. As the chart shows, the median return one year after a bear market low is 35.34%.
3. Stocks keep paying dividends.
Did you know the price of stocks isn’t the only thing providing returns over time? Since 1929, 42% of the total return of the S&P 500 can be attributed to reinvesting dividends.
Dividends are a way for a company to distribute profits to its owners. As a holder of stocks (even through mutual funds or ETF’s), you receive these dividends. Most people reinvest these cash payments, buying more shares of the stock (or mutual funds).
Currently, the dividend yield of the S&P 500 is around 2.3%. While some companies in hard-hit sectors (restaurants, hotels) are expected to cut their dividend, most companies will continue to pay theirs, buying more shares for you in a time when prices are low.
If you don’t think 2.3% sounds like a high dividend, compare it with the 30-year US Treasury bond. At time of writing, the yield is around 1.55%. Even for income investors, stocks provide a higher yield than government bonds! Furthermore, dividends have historically grown at a rate higher than inflation.
When the market is selling off, it can be hard, especially if you’re not in a position to put cash to work. Remember, dividends provide a source of return that allows you to reinvest and buy more shares at a lower price.
Sudden market drops can be unsettling. Our natural response is to do something. But sticking with your plan helps put you in the best position to capture the recovery.
