The bear market returns

In the year 2000 a famous US bull stock market that started back in 1982 came to a spectacular end with the Nasdaq crash, and since bottoming in March 2003 markets have swung upwards with a vengeance but have still not retraced their 2000 highs. That is because we are in a bear market and the next step is down, and over the past few weeks that is where markets have been heading.

Bear markets can do terrible things to the assets of long-term investors. The typical length of a US bear market is 17 years, and the problem is that while share prices will have their ups and downs along the way, they will end a bear market unchanged on where they began, and that is not accounting for inflation.

So to buy a mutual fund to hold for long term asset appreciation can be a hopeless investment in a bear market. Besides which 17 years is a long time when you consider the average investor saves for retirement perhaps over 40 years.

Valuation swings

In a bear market what really changes is the valuation multiple placed on stocks. At the height of a bull market like 2000 price-to-earning ratios might top 45, but in the depth of a bear market 6-7 is more typical. Thus a company has to earn around six times as much profit to achieve the same share price at the bottom of a bear market as it would under extremely bullish conditions.

Investors in common shares just can not beat the bull-bear market cycle. The trick is surely to recognize the cycle and avoid investment in shares during a bear market, unless you are a trader riding the mini-cycles of the bear market with particular skill.

Instead there is a well established contrarian investment solution, and that is to switch asset class entirely during a bear market for shares. Commodities in particular have an inverse relationship to stock markets.

Back to the 70s?

The 1970s are the classic illustration of stock market blues and commodity market bliss, and indeed commodity stocks were among the best performers in that decade. Inflation is nowhere near as high as in the 1970s today but the trend is upwards, and commodity prices have been rising for the past five years.

Commodity bull markets average from 14 to 22 years, and so there is little to worry about being late to the party. Certainly this bull market will also have its ups and downs, and we have just hit a down period. But if the overall trend is upwards then buying on the dips and avoiding trying to call a top is an excellent strategy.

For those not interested in investing in individual commodity stocks or physical commodities, then there are more and more commodity funds available. It could be that sidestepping the bear market in shares is the best investment advice available today, and that buying a commodity fund instead in the right option.