The last five years are chock-full of lessons that can help you make wise decisions when equity prices are falling.
2023 has been an epic bull market. And with the Fed projecting multiple rate cuts next year, it seems like the worst of inflation and rising interest rates are behind us.
However, equity valuations have gotten higher. And as much as folks like to predict what will happen next year, the truth is that no one really knows, just as no one knows when the next bear market will occur.
When that bear market inevitably arrives, however, it's important to understand why bear markets can actually help you in the long run and how to prepare for one that could come as soon as 2024.
Image source: Getty Images.
Recent bear markets were incredible buying opportunities
Over the last five years, there have been three sizeable selloffs in the S&P 500. Here’s a chart showing the S&P 500’s performance since Oct. 1, 2018, which was right before the late 2018 crash induced by the U.S.-China trade war.
Data by YCharts.
After falling 19.6% between Oct. 1 and Christmas Eve in 2018, the market proceeded to rally -- wait for it -- 37.4% between Christmas Eve 2018 and the end of 2019.
What followed was the pandemic-driven sell-off of 2020, which also proved to be short lived. The S&P 500 soared 16.3% in full-year 2020 and then another 26.9% in 2021.
2022 featured what was in hindsight an overdue sell-off after years of outsized gains. Rising interest rates and inflation made it harder for companies to invest and grow as quickly. But the sell-off in many high-quality stocks proved to be overdone.
For example, Alphabet stock ended last year with a price-to-earnings ratio of 17.6 -- a steal for a high-quality cash cow. It hasn't been too surprising then to see the stock gain 55% year to date as part of a broadertech-fueled rally.
The lesson from the last five years is that every major sell-off in the broader stock market has proven to be a buying opportunity. However, that doesn’t mean that every industry is firing on all cylinders right now.
There are pockets of the stock market that are underperforming, such as utilities and consumer staples. Specific industries like renewable energy have also been hit hard by a cyclical downturn and higher interest rates.
Even during a bull market, there will be sectors that aren’t doing well for a mix of good and bad reasons. The trick is to not abandon a good investment thesis all because it's under short-term pressure. Instead, hold or even add to a position when the market gives you the opportunity to do so.
Investing through volatility
The biggest advantage that individual investors have is time. Unlike Wall Street, which is pressured by quarterly forecasts, price targets, and a slew of other factors that incentivize it to be short-term focused, an individual can prioritize achieving their long-term financial goals. This takes the pressure off to sell into the weakness of a bear market.
In fact, a bear market can give you more shares of the companies you love, and make you more money over time. A good, old-fashioned buy-and-hold strategy paired with dollar-cost averaging is just a way to consistently accumulate shares. If you don’t plan on selling a stock for several years, any short-lived volatility allows you to buy more shares and build a bigger position. Without a bear market, your dollars wouldn’t go as far.
Applying the same principle to individual stocks or a sector can work wonders over time. Here’s a look at how the Magnificent Seven stocks -- a term coined by Bank of America analyst Michael Hartnett to describe Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta Platforms, and Tesla -- performed in 2022.
Data by YCharts.
Here’s how those same seven stocks are performing so far in 2023.
Data by YCharts.
While it would have been especially impactful to have doubled down on these names during the sell-off, simply holding through periods of volatility can still work wonders.
One of the biggest mistakes investors make during a bear market is trying to time the bottom. In hindsight, 2022 was an incredible buying opportunity. No one knew when the sell-off would end, but history has shown investors time and again how the market does eventually rebound.
You can avoid stress and simplify your investing strategy by staying the course, even when stocks are falling. Pairing this straightforward approach with consistent saving allows you to sidestep impulsive and likely regrettable decisions while still generating solid gains for your portfolio.
Embrace volatility
The stock market produces, on average, a gain of 9% to 10% per year. The price of admission is patience through periods of volatility. Instead of focusing too much on what your portfolio is worth during a bear market, it’s better to view a sell-off as an opportunity to buy shares of companies on your watchlist.
The stock market could keep rallying in 2024, and we could avoid a downturn altogether. But eventually, another bear market will happen. Having a plan and knowing how you’ll react before it happens will help you see the bright side of things and use the volatility to your advantage.
Bank of America is an advertising partner of The Ascent, a Motley Fool company. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Bank of America, Meta Platforms, Microsoft, Nvidia, and Tesla. The Motley Fool has a disclosure policy.
