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Content for this page, unless otherwise indicated with a Fidelity pyramid logo, is published or selected by Fidelity Interactive Content Services LLC ("FICS"), a Fidelity company with main offices in New York, New York. All Web pages that are published by FICS will contain this legend. FICS was established to present users with objective news, information, data and guidance on personal finance topics drawn from a diverse collection of sources including affiliated and non-affiliated financial services publications and FICS-created content. Content selected and published by FICS drawn from affiliated Fidelity companies is labeled as such. FICS selected content is not intended to provide tax, legal, insurance or investment advice and should not be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security by any Fidelity entity or any third-party. Quotes are delayed unless otherwise noted. FICS is owned by FMR LLC and is an affiliate of Fidelity Brokerage Services LLC. Terms of use for Third-Party Content and Research.

How to prepare for the next bear market

Bear markets may be inevitable, but your portfolio can survive.

  • By Mark Hulbert,
  • MarketWatch
  • – 03/07/2014
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Few investors find solace from knowing that, if they wait long enough, stocks will eventually recover from a bear market. After all, as Keynes famously said, in the long run, we are all dead.

Yet history shows that typical bear-market recovery times are hardly "the long run." Since 1926, it has taken an average of 3.3 years for stocks to surpass their high set before the typical bear market began.

Unless you think the next bear market and subsequent recovery will be worse than average, sticking with stocks is the best response to the certainty that, sooner or later, the current bull market will come to an end.

Discussions about bear-market recovery times are often dominated by what happened after the 1929 crash. The Dow Jones Industrial Average (.DJI) didn't surpass its 1929 pre-crash peak until 1954, 25 years later.

Yet the Dow paints a distorted picture for at least three reasons. One is that it reflects just 30 stocks. Another is that it doesn't include dividends, which represented a big portion of stocks' total return in the 1930s.

A third reason is deflation. According to data compiled by Yale University professor Robert Shiller, a dollar's purchasing power grew by more than a third between 1929 and 1933. So a big chunk of the Dow's apparent decline disappears after we adjust for the deflation.

After correcting for all three of these factors, I found that the stock market surpassed its 1929 pre-crash high in March 1937 — 7½ years later. 

The recovery time from the 2007-09 bear market — which coincided with the worst economic downturn since the 1930s — was 5.3 years. In January 2013 the stock market surpassed the level at which it stood on Oct. 9, 2007.

Both of these recovery times were longer than the 90-year average, which I calculated based on a list of 28 bear markets compiled by Ned Davis Research. (The firm, based in Venice, Fla., uses multiple criteria, including depth of loss and duration, to define a bear market.) The average loss of the bear markets on the list was 30.2%, adjusted for inflation and dividends.

It is not surprising that these two recovery times were longer than average, since in each case the bear-market losses were also worse than the norm. The decline in the case of the 2007-09 bear market was 55%; between the 1929 high and the 1932 low, the market fell an incredible 80%.

What about Japan? Does its market's dismal performance over the past 25 years constitute a major exception to the relatively quick average bear-market recovery time? The Nikkei 225 Index (.N225) today is still more than 60% below its 1989 peak.

We shouldn't generalize from Japan's experience, according to William Bernstein, co-principal of Efficient Frontier Advisors, a money-management firm in Eastford, Conn. A stock portfolio that is well diversified globally runs little risk of suffering from the deflationary mistakes the Japanese monetary authorities made, he said in an interview.

"The probability of deflation occurring simultaneously in a large number of countries is vanishingly small," he says.

The key is to be well-diversified globally. For exposure to the entire U.S. stock market, two low-cost exchange-traded funds appropriate for buy-and-hold investors are Schwab U.S. Broad Market (SCHB), with an annual expense ratio of 0.04%, or $4 per $10,000 invested, and SPDR S&P 500 ETF Trust (SPY), which charges 0.09%.

Two ETFs that provide low-cost international stock exposure are Vanguard FTSE All-World ex-US (VEU), with annual fees of 0.15%, and iShares MSCI ACWI ex-US (ACWX), which charges 0.34%.

To be sure, there are no guarantees that future bull markets will as quickly erase the bear markets that will precede them. Bernstein worries that the U.S. stock market's average return in the 21st century is unlikely to be as high as it was in the 20th, and that as a result recovery times could be somewhat longer.

One way to overcome this possibility at least somewhat is to invest in undervalued stocks. Adjusting for dividends and inflation, so-called value stocks — those with the lowest ratios of price-to-book value, a measure of net worth — have exhibited the quickest bear-market recovery times over the past 90 years of any of the investment styles measured by Eugene Fama and Kenneth French, finance professors at the University of Chicago and Dartmouth College, respectively.

You can get exposure to the value sector of the market via the iShares Russell 3000 Value ETF (IWW), with a 0.26% expense ratio. Those willing to incur an extra measure of risk in this sector can focus on small-cap value stocks — those with a market capitalization of less than $1 billion to $2 billion. This sector historically has had even quicker recovery times, though it also tends to lose more in bear markets. The SPDR S&P 600 Small Cap Value ETF (SLYV) charges fees of 0.3%.

Another way to at least partially ameliorate the effects of lower expected U.S. equity returns is to overweight cheaper foreign stock markets. Emerging markets trade at significantly lower valuations than the U.S. market, for example, as do some European countries.

Two low-cost ways to invest in those regions are the Vanguard FTSE Emerging Markets ETF (VWO) and the iShares Europe ETF (IEV), which charge fees of 0.15% and 0.6%, respectively.

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Content for this page, unless otherwise indicated with a Fidelity pyramid logo, is published or selected by Fidelity Interactive Content Services LLC ("FICS"), a Fidelity company with main offices in New York, New York. All Web pages that are published by FICS will contain this legend. FICS was established to present users with objective news, information, data and guidance on personal finance topics drawn from a diverse collection of sources including affiliated and non-affiliated financial services publications and FICS-created content. Content selected and published by FICS drawn from affiliated Fidelity companies is labeled as such. FICS selected content is not intended to provide tax, legal, insurance or investment advice and should not be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security by any Fidelity entity or any third-party. Quotes are delayed unless otherwise noted. FICS is owned by FMR LLC and is an affiliate of Fidelity Brokerage Services LLC. Terms of use for Third-Party Content and Research.
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