Avoiding Bear Markets

There have been three bear markets in the S&P 500 total return since 1970 where the maximum loss has exceeded 40%. In September of 1974, the loss was -42.64%. In September of 2002 the loss was -44.73% and in February of 2009, the loss was -50.95%. Are there any common characteristics of these tops prior to these bear markets which would have allowed us to avoid suffering the subsequent terrible losses.

Below is a plot of the normalized performance four years prior to the market bottom. It is normalized such that two years prior to the market bottom is set at 1.0. Note that the overall markets gradually deteriorated until the final breakdown and subsequent bottoms. These three market tops are considered rounded market tops.

It is possible the construct an indicator that would help to avoid the steep losses following these types of tops. The simplest indicator is to invest in the market when it is above a moving average. An "N" month moving average is an average of the "N" most recent months of the stock market's values. Below is a plot of the S&P 500 Total Return along with a 16 month moving average.

If you were out of the market when the market was below the 16 month moving average you would avoid major losses in the three bear markets mentioned above. Instead of having losses of -42.64%, -44.73% and -50.95% you would have experienced losses of -21.32%, -13.12% and -10.55% respectively.

Using a moving average as an indicator to time the market can help minimize losses. It also impacts overall volatility and return. Below is a table of overall performance for various moving average market timing indicators from 12/31/71 through 9/30/17. For this analysis, it assumes that when funds were not in the market they were in cash earning 0%. It also doesn't factor in any tax consequences for selling stocks.

 

Disclosure:

The information presented here is the opinion of the author and may quickly become outdated and is subject to change without notice. All material presented in this article are compiled from sources believed to be reliable, however accuracy cannot be guaranteed. No person should make an investment decision in reliance on the information presented here.

The information presented here is distributed for education purposes only and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or participate in any particular trading strategy.

Performance data showing past performance results is no guarantee of future returns.

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