Understanding bear markets

Bear markets are awful, but they are a normal part of the investment environment and occur about every five to eight years. Investors should understand them and get used to them.

A bear market will, virtually every time, catch you unaware. Every bear market is different in their characteristics but identical in their underlying causes. The cause is simple: excess money (cheap money) is available, and is invested in an area of the market that appears to have excess return potential with very little risk attached - the “hot” part of the market.

Recovery is also normal

Recovery is also a normal part of the investment environment. The pain is taken, losses are made, firms go bankrupt and people lose money, but the system seems to survive and prosper again, probably in a shorter time period than all forecasters predict.

The BIG lesson from bear markets

There is only one real lesson from previous bear markets: do not panic. Do not think that all the good reasons why you bought something are now no longer valid. However, if you bought something that was wrong in the first place, sell.

Five lessons for investing in bear markets

Lesson no 1

The asset class that caused the recover to the previous highs, or the same fantastic returns as in long time. In fact, the “bubble” disappear. bubble will not at all, nor give the past, for a assets almost disappear.

True bubble assets:

* Geared UK / European / USA property investments. Direct un-geared property investments will recover.
* Geared “hedge funds” or “alternate investments” (excluding true hedge funds).
* Any investment in very low liquidity assets.
* Heavily geared Investment Banks.
* Geared commodity funds.

If you own these, it is probably best to take your losses and sell. There may be a bounce, but the outlook is poor for a long time.

Lesson no 2

Normal assets also suffer from the bear market. They also fall, probably not by the same degree, but they recover and return to “normal”. They may not be at the bottom yet and you do not know how long they will take to recover, but they will recover. These include normal industrial and financial shares, and resource shares, although resource prices will most likely not return to the previous highs.

Lesson no 3

Bear markets are the time to invest in “normal” assets and not the time to sell. Normal assets only become really cheap during a bear market.

Lesson no 4

Right now, everyone will tell you how the “system is broken”. The geared part of the system - certain hedge funds, investment banks, over-exposed and over geared property investments, etc. - are broken, but the system is not. The recovery will happen and is normally quicker and stronger that anticipated.

Lesson no 5

The share market in particular will recover before any good news actually appears - this is normal. Markets anticipate the future. There will also always be a few false starts and falls back to the previous lows. A key sign of the bottom of a share market is when the market does not fall when really bad news comes out.

In a nutshell

If you are unfortunate enough to own the “Bubble Assets”, don’t wait for a sustained recovery after the initial bounce. If you own “Normal Assets” sit tight and don’t panic. If you have cash, congratulate yourself, and then buy for the longer term. The market may fall again, but the time to buy for the longer term is in a bear market.