Bear markets matter, and they matter much more than you think. (Read Part 1 Here)
In part-1, we discussed the differences between a “correction” and a “bear market.” But what is often missed by mainstream analysis is the long-term damage done to investor’s financial outcomes.
Now and then, you will see a version of the following chart floating around suggesting that over the long-term, “bear markets” don’t matter.
If you only do a cursory analysis of the chart, such would undoubtedly seem to be the case.
The problem is the analysis is exceptionally deceptive due to how math works.
It’s the Math
Notice that the chart uses percentage returns. As noted, that is a deceptive take if you don’t examine the issue beyond a cursory glance. Let’s take a look at a quick example.
Let’s assume that an index goes from 1000 to 8000.
1000 to 2000 = 100% return
From 1000 to 3000 = 200% return
The next 1000 to 4000 = 300% return
…
The final 1000 to 8000 = 700% return
No one would argue that a 700% return on their money wasn’t fantastic.
So, why should you worry about a correction when you just gained 700%. Right?
The problem with using percentages to measure an advance is that there is an unlimited upside. However, you can only lose 100%.
In our example, while our hypothetical investor garnered a 700% return, a 100% loss reverses that gain to zero. Nothing. Zip. Nada.
That is the problem of percentages.
Valuations & Forward Returns
As noted in Part-1, the other issue investors must account for over the long-term is inflation. The first chart above is the inflation-adjusted S&P index. For all examples in this article, I am using Dr. Robert Shiller’s monthly data for consistency.
As we discussed, the three most important factors are drawdowns, inflation, and life expectancy.
Of course, these long periods of very low returns are a function of valuations.
While it may “appear” that investing your money will assure you a return over time, the problem is there are extended periods where returns have been close to zero and even negative.
The two charts below show the inflation-adjusted total (dividends included) return over both 10-year and 20-year periods.