Surviving the Next Bear – Strategies to Profit from a Market Crash
The Stock Market is a powerful money-making machine that can make you rich and financially independent. But Stock Market Crashes are part of the game. The next one may be around the corner.
But if you see a Grizzly Bear, it’s too late to run away. It swims, climbs trees and runs at 60 km/h. Potential Bear encounters need to be prepared for. The same applies to Bear Markets. But, while a trip to Alaska is optional, market crashes are not. They are guaranteed to happen.
KEY TAKEAWAYS
- If you’re unprepared, you can lose everything. The worst market crashes, including in Russia and China, completely wiped out investors exposed to a single country.
- The 1929 crash wasn’t the worst. It took seven years to recover. But you could have reduced that time with bonds that help in deflationary periods.
- In most cases, recovering from a market crash will take a couple of years.
- But if you invested only in Japanese Stocks in the 1980s, this would have taken decades. International diversification can be a lifesaver.
- Prolonged inflationary downturns are the worst since Stocks and Bonds underperform at the same time, like in the 1970s. But Gold, other commodities or Inflation-linked Bonds help make your portfolio more resilient.
- In reality, if you are prepared, it’s almost impossible to lose money in the long term. Most bear markets are like black bears. They are usually inoffensive and an excellent opportunity to invest cheaply.
Here is the full analysis
Bears inhabit some of my favourite adventure spots – Yukon in Canada, Alaska in the U.S. and Hokkaido in Japan.
Wild camping while cycling comes with risks, but preparation can largely mitigate them.
Today, let’s look at:
- The Three Brown Bears (also called Grizzlies) – Each represents a particular risk – Deflation, Inflation, and Concentration. We look at the best strategies to mitigate each one of them.
- Black Bears – Why they are the easiest way to increase wealth.
With that in mind, I list some practices to help you construct a portfolio, whether you’re facing a Grizzly or a friendly Black Bear. What are the odds of seeing a Grizzly?
Meet the Three Brown BearS
Was it possible to lose it all?
Investing in single countries, losing between 50% and 90%, and waiting decades to bounce back, was not uncommon. Circumstances were extreme – wars, revolutions or high inflation.
Some investors lost it all. In the wake of the Russian Revolution, the Saint Petersburg Stock Exchange was permanently closed. Under the Bolshevik government, private ownership of businesses and property was abolished, and industry and banking were nationalised. The Shanghai Stock Exchange shared a similar fate in 1949.
Spectacular market crashes and painful recoveries
In other countries, it took decades to recover, assuming you didn’t panic or needed cash when you lost your job.
But what are the three types of painful bear markets that you may encounter?
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#1 The Mainland U.S. Brown Bear
How To Avoid Being Traumatically Depressed
It matters which Bear species you encounter. Brown Bears are particularly dangerous. When you see a Grizzly Bear, the worst thing you can do is try to run away. You need to be prepared – have a bear spray, keep the food away, stay calm and know how to gently talk a bear out of charging you. Yes, I’m dead serious.
What happened in 1929? Below is the profile of $1,000 invested at the peak of the market, adjusted for inflation and dividends.
The Great Depression - Loss On $1,000 Invested in U.S. Equities
How Long Did It Take To Bounce Back?
- It was a deflationary period, so nominal losses were higher than real losses. In 1937 the market recovered. But another black swan event, WWII, followed.
- Dividends were usually not accounted for, and represented close to 14%.
- The pain was, in reality, bigger because investors didn’t invest in a Total Market Index. Instead, the narrow Dow Index arbitrarily excluded some stocks like IBM.
What would have saved Investors? Bonds.
Some of the most intelligent investors claim that you must stay the course by injecting more savings in tough times.
I think that they are living in a fantasy world. Let’s face it. What’s the likelihood you would have additional savings to inject during a Great Depression? It’s one of those periods when not only your neighbour loses a job. You do too.
However, if you had Bonds, then at least you could rebalance in such scenarios and buy cheap stocks. You could also sell them to fund your needs.
Bonds protect you in all deflationary scenarios. During the Great Depression, from 1928 to 1940, the cumulative real total return of 10-yr Treasury Bonds was 100%.
You can also use my Bond ETF calculator to understand how bonds increase in price during a crisis and how to adjust duration.
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Today's prices are not coming back!
In 2024, we Will be increasing coaching service prices.
Sometimes individual sessions are very helpful to get past your investing concerns. Our readers asked us to create a coaching service. And we’re proud to say, that some of them even ditched their Financial Advisors, after experiencing the value we provide. Some of the topics we recently discussed include:
- How much money do I need to retire with higher inflation?
- Medium Term or Long Term Bonds with today’s yields?
- Risks and Returns of Money Market Funds
- Asset Allocation for 10-15 year goals with narrowing returns between Equities & Bonds
- Merits of UK Trusts that invest in unlisted companies
- Traps with choosing brokers – PFOF & Risks of moving to another country
- International Situations – Choosing ETFs when leaving Europe
#2 The Largest Bear on Earth - The Kodiak Grizzly
How To Avoid Being Eaten Alive By Inflation
Kodiak Island in Alaska is known for being inhabited by some of the biggest bears on earth. Their weight can exceed 750 kg and I saw them running, at 50 km/h. However, unless you charter a Cessna to visit the island, you won’t hear much about them.
The Great Depression and the Japanese lost decade are often discussed as obstacles to Early retirement strategies relying on the Stock Market. But until 2021, hardly anyone talked about the 1970s, which were perhaps the most dangerous for an unprepared investor.
Below are the inflation and dividend-adjusted drawdowns for UK Investors who invested 100% in Domestic Equities at the peak of the market.
INflation Shock - Loss on £1,000 InvestED in UK Equities
How Bad Did It Get?
During the 1970s, the real price of imported oil in the U.S. and much of Western Europe increased 6-fold. Initially, stocks were hit the hardest, declining 50% within 18 months in the US, and 73% in the UK.
But, by 1981 as inflation accelerated, US Treasuries also declined by 40%.
Stocks and bonds that are usually negatively correlated, but in this case both declined at the same time.
What WOULD Have saved Investors? Inflation hedges.
Inflation Protection - How It Saved a 60/40 Portfolio
Inflation-Linked Bonds or Commodity ETFs were not available back in the 1970s. Gold is not always as reliable as other inflation hedges, but with consistent very high inflation it may play a role. While, I don’t have high-quality U.K. Bond Data dating back to the 70s, U.S. markets reacted in the same way:
- The Red surface is the drawdown of a 60% Equity / 40% Bonds Portfolio. From 1970 to 1986, it returned 2.3% annually.
- The Yellow is a 60% Equity / 20% Bonds / 20% Gold Allocation. The annual average return was 5%.
Rebalancing also played a role here. I have assumed it’s done annually, so you effectively sold expensive Gold and bought Equities during that period.
#3 the worst attack in Japanese history - The Ezo Bear
Proper Arming for a Bear encounter
If you ever go to Japan, don’t miss out on Hokkaido and Shiretoko National Park (知床国立公園), one of my personal favourites.
Shiretoko is the most densely populated area by Brown Bears on the planet. Today, it’s a highly localised threat.
However, in late November 1915, on the Eastern side of Hokkaido island in Sankabetsu, a 2.7m tall bear of 350 kg appeared after a failed hibernation. The local families shot at him, but failed to kill the bear. A gun is not a great way to neutralise a bear, which I learned in Alaska. You may miss vital organs.
What the locals probably didn’t know is that bears, can have a heart rate as low as 8 beats per minute. This allows them to conserve energy and slow blood loss from injuries. The bear didn’t attack any human until it became enraged by the shot.
Over the next two weeks, the bear returned multiple times, killing nine and injuring many others. The locals were so desperate, that they even lured the bear with the corpse of a victim. It took veteran snipers from the Russo-Japanese War to finally hunt him down.
Today, you can avoid localised threats in the markets. And adopt tools, e.g. geographically diversified index funds, to be resilient to local risks. Japanese investors learned the hard way, what happens if you don’t. Especially if you’re in the biggest bubble, the modern World has seen.
Japan's Lost Decade - Loss on ¥1,000 Invested in Japanese stocks
Stock Returns: x17 vs x4, a no-brainer.
In the 1980s, Real Estate was making Japanese investors very rich. According to Charles Kindleberger and Robert Aliber, by 1989, the market value of the land under the Imperial Palace in Tokyo was greater than the market value of all the real estate in California.
The market value of Japanese real estate was twice the market value of U.S. real estate, even though the land area in Japan is 5% that of the United States and 80% of Japan are mountains.
The profits flew into stocks. For a Japanese investor in the 1980s, it may have looked reasonable to eliminate the rest of the World from a portfolio, since it was a drag on performance.
No wonder:
- The market value of Japanese stocks was higher than the market value of U.S. stocks, even though Japanese GDP was less than half of U.S. GDP.
- By investing in 1970, Japanese Stocks would have gone up x17 by the end of the 1980s vs only x4 for US Stocks. And that’s not even taking into account that the USD lost 60% relative to the Yen over that period.
Japanese, US and European Equities Since the 70s
What Would have saved Investors? International Diversification.
International Diversification may have been a lifesaver at some point in the past century, if you were based in any country outside the US. For US Investors, it was a return-enhancing tool during some periods.
Ultimately, history may prove it to be a risk tool, even for U.S. investors.
Are you willing to bet that these relative shares won’t change in the next decades? Remember, country diversification also brings sectoral diversification.
Relative Size of Equity Markets from 1900 to 2020
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BLack Bears: once-in-a-generation opportunities
Relative to Grizzlies, Black Bears are less dangerous.
They charge only when they have no other alternatives. Or when defending the cubs.
Black bears can easily be confused with Grizzly Bears because it’s not the colour that defines them. An easy way to spot the difference is the shape of their ears. They have pointed ears, while Grizzlies have rounded ones.
Markets can be more tricky. A Black Bear is a buying opportunity. A Grizzly can be a bit more challenging to navigate. But you initially can’t tell the difference.
1987 Flash Crash - Loss on $1,000 Invested in U.S. Equities
In the Flash Crash in 1987, the S&P 500 finished the year flat despite the worst one-day performance of the Index. In October, on Black Monday the Dow Jones lost c. 23% and S&P 500 just over 20%.
The above graph shows the drawdown from the market peak but doesn’t consider the prior rally.
The recovery represented positive returns when you take January 1987 as a starting point.
COVID-19 - Loss ON $1,000 Invested in U.S. Equities
Narratives can make your strategy derail. Especially events that happen once in a lifetime. But Stocks are unpredictable, especially when second-order effects like the FED offset first-order effects like the pandemic. In 2020, the S&P 500 ended the year with 17% gains.
The rise of algorithmic trading may amplify certain future crashes and may make them shorter. Central Banks’ proactive stance and strong market demand may make some recoveries shorter. Or at least that’s what market participants tend to believe.
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BRown vs black Bears
What are the odds of a Brown Bear?
I assume you’re sufficiently diversified, so I looked at World Index Bear Markets. This also includes sectoral diversification. You wouldn’t want to experience an 78% NASDAQ drawdown.
Over the past century, we had:
- On average, one bear market (with at least a 20% drop) per decade.
- After World War II, two-thirds of these were Black Bears.
- Even more opportunities to buy cheaper stocks. Market corrections of at least 10% have occurred, on average, every two years.
Black vs Brown Bears for World Equity Index
| Start | End | % Drop | Bear | Context |
|---|---|---|---|---|
| 8/31/1912 | 7/31/1921 | -39.4 | Brown | World War I |
| 8/31/1929 | 6/30/1932 | -75.4 | Brown | Great Depression |
| 2/28/1937 | 5/31/1940 | -39.8 | Brown | World War II Begins |
| 5/31/1946 | 9/30/1949 | -26.4 | Black | Post-World War II |
| 01/31/1969 | 6/30/1970 | -25.4 | Black | Vietnam War |
| 3/31/1973 | 9/30/1974 | -42.4 | Brown | OPEC I |
| 11/30/1980 | 6/30/1982 | -24.6 | Black | OPEC II |
| 8/31/1987 | 11/30/1987 | -22.0 | Black | 1987 Crash |
| 12/31/1989 | 9/30/1990 | -24.3 | Black | Iraq War |
| 3/31/2000 | 9/30/2002 | -49.7 | Brown | Internet Bubble |
| 10/31/2007 | 2/28/2009 | -54.9 | Brown | Financial Crisis |
| 1/31/2020 | 4/30/2020 | -21.4 | Black | COVID-19 |
What are the strategies?
Brown Bears typically involve widespread job losses, banking failures or frauds. Injecting savings may not always be an option, but rebalancing from high-performing assets like bonds or inflation hedges will allow you to buy cheaper Equities.
- Like with a charging bear, the best defence is to keep calm. Easier said than done.
- Your Time Horizon matters. When approaching retirement, high-inflation Beta assets can provide protection, while a 20-year-old may decide to ride out the bumpy road with just Equities.
- Your other assets can play a role. For example, Real Assets like Rental Properties can provide an inflation hedge for your financial portfolio.
In Real Life, It Won't be as bad.
The good news is that what you read is probably as bad as it gets.
In real life, you don’t invest at the market peak, but average out your entry point. And frequent market corrections and Black Bears provide an excellent opportunity to keep buying into the powerful money-making machine that is the Stock Market. And perhaps reach your goals even earlier.
Oh, and please do visit bear countries. Hokkaido, Alaska and Yukon are some of the most magnificent places I’ve seen!
Good Luck and Keep’em* Rolling!
(* Wheels & Dividends)
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