Bear-market education

Clients need to be reminded that bear markets are a normal part of investing in the stock market. And even with those scary but temporary periods, investing in stocks offers potential long-term rewards that generally are worth the risks.

Using historical U.S.-dollar data on U.S. stocks, I count 14 bear markets in the 144 years through to September 2014. Using monthly data, the average bear market declined by 34% during a drop that lasted 15 months – and then spent an average of 31 months climbing out of the cellar to pass the market’s previous high. Bear markets have surfaced once every decade or so, on average. Canadian dollar-denominated global stock market returns show similar loss and recovery statistics, but with a higher rate of incidence.

My Canadian market data cover about 59 years through this past September. Our heavier commodities exposure has resulted in a higher frequency of bear markets – eight in all, for an average of one bear market every 6.5 years, on average. The other statistics aren’t vastly different from the longer-term U.S. data. The average Canadian bear market saw stock prices drop by an average of 32% during a decline lasting 11 months – taking two years to recover fully.

So, every eight years, on average, it’s fair to expect stock market investments to lose one-third of their value – then spend a total of three or four years underwater.

Interestingly, many past bear markets have clustered together. Between 30% and 40% of North American bear markets began within two years of the previous one ending. Canadian stocks, for example, experienced three bear markets between April 1998 and late 2008.

Clients from all walks of life share behavioural tendencies. When stock markets are soaring, I’ve often heard clients and other investors say that they don’t want to rebalance their portfolios. On the contrary, they often want to sell their “wimpy” bonds to buy higher-octane stocks. But all it takes is a little decline like the one we saw early this autumn to make clients regret not rebalancing out of stocks and into bonds – to which investors suddenly are attracted.

It’s helpful to remind clients gently of their past instances of expressing these views. With luck, you’ll be able to recall at least three of these instances – even better if you made brief notes of such discussions. More important, remind your clients that the best investment decisions are those that usually feel very uncomfortable. And such reminders are easier to provide when markets are not in the midst of a free fall.

As part of your periodic reviews and “know your client” update process, you also should update your clients’ risk profiles. This is the best, albeit imperfect way to prepare clients for a very natural part of the investing process.

Not only will your compliance department love you for it, so will your well-prepared clients the next time markets take them for the rough part of the long-term ride.

Dan Hallett, CFA, CFP, is vice president and principal with Oakville, Ont.-based HighView Financial Group, which designs portfolio solutions for affluent families and institutions.

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