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Could Equities Fall Back to 2009 Levels?

October, 2014

Yes, according to historical data on previous bear markets.  The average bear market has wiped out over five years of gains with an average decline of 38%.  However, the three deepest downturns (as measured by the duration of the previous bull market wiped out) each negated approximately 12 years of returns on average.  During the last downturn ending in 2009, a 60-year old investor would have seen their wealth evaporate back to age 48!  We are not calling for an imminent crash, although we think valuations look dangerously lofty and built on the false pillars of low interest rates, accelerated stock buybacks, and government money printing.  These forces can keep pushing the equity markets higher, but they are all artificial and the pendulum will swing back once they falter.

Most investors are blinded into focusing on how they are keeping up with the S&P 500 on a quarterly basis and lured into buying more stocks as the market rises (so called “rear-view investing”).  The real experts know that building and maintaining wealth is largely an exercise of compounded math.  Making money on the upside, yes, but avoiding the big haircuts that bear markets bring.  Keep in mind that an investor who loses the average 38% during a bear market needs a return greater than 60% just to get back to even.  If an investor was able to get more defensive near the market top and held losses to half of the decline (or 19%), they would need a much more reasonable 23% to get back to even.

The experts also realize that wealth is created in bursts.  They’ve gotten rich by doing the opposite of the crowds at inflection points, but patience is a virtue.  Just when emotions tug average investors into buying more equities, the experts scale back, remain patient, and avoid the full damage of these bear markets. By doing so, they are then positioned to “play offense” near market bottoms and buy into cheap valuations as fear and uncertainty consume the masses.  For investors whose emotions are tugging them into the rising equity markets, buyer beware.