On Pullbacks, Corrections, and Bear Markets - Risk Coexists with Rewards

There’s a new generation of traders and investors who have never been through a bear market; yet, what you do during the inevitable downturns determines if you’ll be a successful investor.

Thanks to apps such as Robinhood and InvestBamboo, investing in U.S. stocks is now available to everyone with a smartphone and at least $20 to spare. However, it also means that there’s a new generation of traders and investors who have never been through a bear market. While anybody can make money in a bull market, it is what do you or don’t do during the inevitable downturns that determine if you’ll be a successful investor or not.

The trading week that ended on Friday, September 4 was a mixed bag with an exhilarating peak and a subsequent gut-wrenching decline. As of Wednesday, September 2, the S&P 500 was peaking at $3,580.84 and some stocks such as Zoom and DocuSign were delivering 40% and 20% trading gains. Not many mainstream cryptocurrencies can boast of such daily gains in recent times. 

And then, it hit. There was blood on the streets, Zoom gave back about 13% of those gains on Thursday and Friday, and overall, my portfolio was red as other stocks took haircuts.

Pullbacks, Correction, and Bear Markets

A 5% to 10% decline in the price of a stock during a rally is called a pullback. It is normal, it mostly happens because traders and speculative investors take profits off the table. You can think of it a momentary breather in a climb uphill. 

A 10% to 20% decline in the price of a stock is regarded as a correction. It typically happens when the market thinks that the bullish sentiment on a stock/index has lost touch with the reality of what the underlying business is inherently worth. Hence, the price is CORRECTED to more reasonable levels.

A 20% decline or more is a full-blown crash that pushes a stock or the general stock market into what is regarded as a bear market. Pessimism tends to breed pessimism; hence, when a stock enters the bear territory, it is often hard to predict where the absolute bottom will be and the stock will most likely fall much more than you expected it to fall. 

Are stocks pulling back, correcting, or heading into a bear market?

Yes, there’s blood on the street, but the losses on the stocks in my portfolio are barely scratching the pullback range.

In the last 5 days,

• AMD is down 4.58%

• CRWD is down 3.14%

• FSLY is down 12.69%

• MSFT is down 5.91%

• ROKU is down 5.85%

• SHOP is down 6.61%

• ZM is up 20%

• ZYNG is down 4.11%

Investing in stocks is not a sprint, it is a marathon. The declines of the stocks in your portfolio over the last 5 days might be making you jittery, but when you review that performance against the long game, you’ll discover that the drop in price is not much of a big deal.

Overall, my portfolio return in the YTD is still about 43% up. If you have Tesla in your portfolio, your overall portfolio performance will probably be higher.

The table below compares the performance of the stocks in my portfolio in the last 5 days against their 1-year and 5- year performances.

*: Hasn’t been on the market for up to 5 years

If you aren’t gambling, trading, or speculating; an objective look at the individual stocks in your portfolio or the overall performance of your portfolio in the last 5 trading days will show you that is not as bad as it looks. 

What if the current decline is the start of something worse?

Bull markets and bear markets are two sides of the same coin. Bull markets are great, bear markets are inevitable. I dare say, without bear markets, there won’t be bull markets. If there wasn’t a risk that the stock market could crash, there won’t be an opportunity for profit, - risk coexists with rewards.

I don’t want to go into a conversation about whether or not a bear market is on the horizon, it is a highly nuanced conversation, the coming U.S. elections and the fact that Trump is in the equation is a wild card, and COVID-19 remains the wildest cards of all.

However, even if we go into a bear market, it won’t be the end of the world. When you invest in the right stocks are and willing to wait, it is a positive-sum game because the pie gets bigger over time. The rate at which the pie gets bigger might slow down, halt, or even suffer a reversal during a bear market; however, the bear market will bottom and stocks will return to winning ways. 

Bear markets are don’t last. The 2007 to 2009 bear market lasted 27 months and the stock market was down by about 59%. The 1973 to 1974  bear market lasted 21 months and the stock market declined was down by about 48% during that period. The 1929-1932 bear market lasted 34 months and the stock market declined was down by an incredible 86%.  

More recently, we had the shortest bear market in history when the Dow Jones Industrial Average (DJIA) crashed on March 11, 2020, and the S%P 500 crashed 34%. The crash lasted only for a few weeks and the S&P 500 was back up 46% by September 02.  

The point is that bear markets are inevitable but they don’t last forever. 

Stay alive

I don’t know if the current bull run will continue, but it’s been on for more than 10 years, so maybe a bear market is on the horizon. However, the most important point is that playing the long game 5-10 years gives enough room to ride the bull on the optimistic side and survive a bear market on the pessimistic side. 

Of course, I’m not advocating holding stocks blindly during bear markets. You need to periodically review the stocks in your portfolio to be sure that the business case that influenced your purchase hasn’t changed significantly. 

That said, the demand and supply dynamics will affect the price of stocks during a bear market; but if you are sure that the fundamentals are still intact, you’ll do well to stay put and ride out the storm. Maybe even buy more of your favorite stocks at a discount.

In my next post, I will write about the deconstruction of bull and bear markets and how you can position your portfolio for success.

Here’s to your investing success.

Victor