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To say the past few months have been tough ones for investors would be a considerable understatement. They’ve been downright awful, particularly for owners of aggressive technology names. The tech-rich Nasdaq Composite (NASDAQINDEX: ^IXIC) now sits 32% below its November high, falling to new 52-week lows just this week.
There are two schools of thought about the pullback. On the one hand, some investors suspect the market’s current momentum could continue dragging it lower. Conversely, after losing one-third of its value over the course of just six months, other investors believe all of the potential downside has already been wrung out, making now a great time to step in.
Which of these camps is right? The best answer: it depends. For the record, though, the odds favor the “buy now” crowd.
Not every question has a clear answer, but…
It’s tricky. Most investors innately understand it’s better to buy stocks when they’re at a low rather than jump in while they’re near a high. Stepping in right now, however, feels like you’re trying to catch a falling knife; if your timing and precision is off, it could hurt. It’s smarter to simply let the knife hit the floor and then pick it up.
Such cliched analogies, however, miss a key point about investing. That is, the distance to the floor and what’s going to happen once the knife reaches it are both known and constant. The market, on the other hand, is inherently fluid and unpredictable, driven as much by emotion as by calculable value. Stocks can move lower than it ever seems like they would, yet they can also bounce much sooner that it feels like they should. Every scenario is different. That’s why the best answer to the overarching question asked above is “it depends.”
Image source: Getty Images.
On the flip side, after more than a 30% tumble from the Nasdaq, now’s arguably the time for true long-termers (investors thinking more than five years into the future) to be putting any idle cash to work.
That’s not to say we’ve seen stocks make a major bottom. That might be the case. We just don’t know. It’s simply to suggest we’re more likely to be closer to a major bottom than not.
And a mountain of data collectively bears this idea out, though we’ll limit our look to the three most supportive highlights.
By the numbers
The first of these data nuggets comes from the Hartford mutual fund company, which says from peak to trough the average bear market lasts 289 days, or 9.6 months. The current sell-off from the Nasdaq has been underway since November 22, or almost six months. Hartford’s math used the S&P 500 (SNPINDEX: ^GSPC) as its benchmark, which peaked in early January and is now priced a little more than 21% below that high… which is just a little over five months’ worth of rout. Even so, it still puts the index closer to the end of the average bear market than the beginning of it. The span of the pullback also puts the S&P 500 closer to Hartford’s suggestion that the typical bear market shaves off 36% of the S&P 500’s value.
In a similar vein, numbers from Bespoke indicate that once the S&P 500 reaches the 20% pullback threshold, the bottom materializes an average of 96 days later. That would put the S&P 500’s ultimate low sometime in September. Don’t get too comfortable on the sidelines though. Bespoke also notes that half of the bear markets investors have suffered since 1945 have hit bottom within just two months of reaching the 20% mark the S&P 500 just eclipsed.
OK, but based on these numbers, even the best-case-scenario implies we’ve still got at least a few weeks before a bottom is made, during which time stocks could continue to fall. Holding out to jump in at the exact bottom is still a problematic strategy as well, however, for a couple of related reasons.
The first of these reasons is, these days the S&P 500 or the Nasdaq Composite are making their bear market lows typically look decidedly bearish. You’ll never know (or believe) a low is the exact bottom until well after it’s made.
The second reason is the biggest and fastest gains of a new bull market take shape right at its onset. Data from brokerage house Edward Jones’ research arm points out that with the last five new bull markets, the S&P 500 gained an average of 25% during their first three months of existence. If you’re not invested at the bottom and remain on the sidelines for a little too long — waiting for proof that what looks like a new bull market really is a bull market — you’ll miss out in a major part of the rebound.
Connecting the dots
Investing can’t be completely reduced to mere statistics, of course. As was already explained, the market is fluid and impacted by emotionally charged opinions of a never-ending flow of new information. Common sense and level-headed thinking are just as important tools to keep in your toolkit as data-based research. It’s entirely possible this bear market could be considerably different than past ones have been.
On balance though, the average long-term investor is better served by buying after major sell-offs than not, even if that buy-in isn’t happening at the exact market bottom. The trick is simply diving in and not second-guessing your decision every day thereafter.
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James Brumley has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
