Sunday, 27 September 2015

Different Types of Bears

Whenever we speak of a bear market, we tend to think that there is only 1 type of bear markets and all bear markets are the same. However, I can think of 2 different types of bear markets (shortened to "bear" hereinafter); the first one is similar to the market downturn that we experienced recently which is fast and sharp. Let's call it the ferocious bear. Examples of the ferocious bear would be the Asian Financial Crisis in 1997/1998 and the Global Financial Crisis in 2008/2009. The second type of bears is gradual but long-winded. Let's call it the long-winded bear. An example of the long-winded bear would be the one that lasted from 2000 till 2003. The figure below shows both types of bears as happened to the Straits Times Index (STI). You should be able to recognise the bears easily.

Bears on STI

What are the characteristics of both types of bears? For the ferocious bear, the decline is both fast and furious. The speed and fury of the bear usually strikes fear into most investors who are more accustomed to peaceful environments. The losses are usually very severe and come quickly. As the bear progresses, you might think that prices have declined significantly enough, but each time you average down, the losses of the newly invested capital are just as severe. You hope the bear would stop for a while so that you could have some respite. But no, the bear would not listen to anyone and continue its forage, slashing anyone who dares to stand in its path. Not everyone would be able to take it. Some investors would sell out with heavy losses, promising never to return to the stock market. Other investors would continue to do battle with the bear despite heavy bleeding. At the depth of the bear, investors would still wonder if things are going to get worse and doubt any recovery as another bear trap. It is a very fearful atmosphere to be in. However, as quickly as the bear advances, the ferocious bear will just as quickly retreat away. Investors who have the mental strength, intelligence and money to buy during the depth of the ferocious bear will usually make a lot of money. On the other hand, investors who are not accustomed to deal with the bear will lose money.

For the long-winded bear, the decline is more gradual but long. Using the last long-winded bear that lasted from 2000 to 2003 as an example, it is actually made up of a sequence of unfortunate events. It started off as the dot-com bust in 2000, followed by the Sep 11 terrorist attack in 2001, US accounting scandals in 2002 and the Severe Acute Respiratory Syndrome (SARS) in Asia in 2003. The losses are severe, but smaller and not as quick as those encountered during the ferocious bear. Attempts to average down usually result in losses but these losses are less severe and easier to stomach. Every day, week or month that you look at your portfolio, you would see fairly severe losses and you would wonder when is there going to be light at the end of the tunnel. It can be very depressing to be mired in heavy losses for a long period of time, but the atmosphere is not one of fear.

How do you manage the 2 different types of bears? Let's start with the easier one, the long-winded bear. Dealing with the long-winded bear is like running a marathon. If you do not finish the race, it is usually because you lack the endurance and drop out half-way. However, if you could persevere and outlast the long-winded bear, you will usually recoup all the losses and make money.

On the other hand, dealing with the ferocious bear needs some skills and luck. It is like running a 110m hurdle dash. Although it is not as long as running a marathon, if you happen to trip over a hurdle, you would not finish the race. Why do I say that? It is because most bears have an economic side to them. As the financial bear is ravaging the financial markets, the economic bear is also damaging the real economy. Not every company will survive the economic bear unscathed. With a long-winded bear, the economic effects are gradual but long-winded. Companies can tighten their belts to tide through the difficult period. But with a ferocious bear, the economic effects are fast and furious. Companies that cannot adjust quickly to the new economic realities will be in trouble. If you happen to invest in weak companies during the ferocious bear, you might not make much money even as the ferocious bear retreats away.

To illustrate further the effects of the 2 types of bears, consider 2 sectors – Property and Oil & Gas (O&G). As you know, property prices in Singapore have been in the doldrums since the Government enacted several property cooling measures several years ago. However, they are not in a sharp decline. Property is considered to be in a long-winded bear. Despite the weak sentiments, you do not expect property developers to be in serious trouble, even though some of them might lose money as the bear progresses. They just need to tighten their belts and hold on until sentiments improve (Note: I am not a long-term fan of properties. See Properties, the Population White Paper and the Land Use Plan for the reasons).

On the other hand, oil prices have been in a fast and drastic decline. O&G is considered to be in a ferocious bear. Not all O&G companies will escape unscathed. Already, some of the O&G companies had to carry out right issues at low prices to raise additional capital. It is thus important to pick the right stocks in a ferocious bear in order to gain from it.

It is not possible to simply say everyone can survive the bears and make a lot of money. Without experiencing it yourself, you will not be able to appreciate the fearfulness of the ferocious bear or the depressiveness of the long-winded bear. However, if you are like most people working and able to set aside some money for investment every month, you actually have the conditions to outlast and profit from the long-winded bear. And if you have been investing for some time and know the value of not investing 100% of your money and keeping some of them in a warchest for subsequent use, you too have the necessary (but insufficient) conditions to outlive the ferocious bear.

Having said the above, not everyone will be able to take the fearfulness or the depressiveness of the 2 types of bears. You need to evaluate for yourself if you are cut out to be an active investor. If you cannot be an active investor, you still can become a passive investor. If you read the above paragraph carefully, "able to set aside some money for investment every month" is akin to Dollar Cost Averaging (DCA) that is normally associated with passive investing. And "not investing 100% of your money and keeping some of them in a warchest for subsequent use" is akin to portfolio rebalancing, which is also a passive investing strategy. The final "necessary (but insufficient) conditions to outlive the ferocious bear" is to invest in an index rather than to pick stocks. While individual companies might not recover, the industry as a whole (or economy) will not fail. Investing in indices is at the core of passive investing. So you see, although passive investing strategies might look dumb and boring, they are actually designed to survive bears! DCA is designed to deal with long-winded bears especially while portfolio rebalancing is designed to deal with ferocious bears in particular (together with index investing)! They have probably been around for as long as bears have existed, and the fact that they have not been sent into extinction by the bears is further proof that they work!

I hope with this blog post, it will help to settle some nerves in the current stock market downturn (I prefer not to rate it as a bear yet). Good luck!

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  1. Hi Chin Wai

    I actually feel that the long winded bears proved to be a more serious stress for investors because it involves years of waiting and emotional patience, and it can take for as long as a lost decades or so.

    Since we've all known about the recent AFC and GFC, the more ferocious type of bear would directly take reference from it, so I think investors are better prepared for it.

    1. Hi B,

      Both types of bears are difficult to handle. For the ferocious bear, investors cannot stop it or know when it will stop. On the other hand, for the long-winded bear, investors don't know how long they have to wait before they recover all their losses.

  2. I agree with B too. The danger is in the long winded bear, not the short lived (but fiercer) one. The boiled frog parable comes to mind.

    1. Both are equally tough to handle. For the ferocious bear, it is easier to handle it if you have a warchest. Still, it is a tough balance on how much to deploy into the market and how much to hold back as the bear progresses. For the long-winded bear, you just have to wait it out.

  3. Let's just buy at two levels of STI...2,500 and 1,500.

    1. Well, having just 2 buying positions and so far apart might be a bit too stringent. But yes, having sufficient warchest at any time is important.