Bear Markets Matter More Than You Think - Part 2

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.

Bear Markets Matter, #MacroView: Bear Markets Matter More Than You Think (Part-2)

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. 

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