The Beauty of a Bear Market

On hindsight, it would have been extremely obvious to a casual observer and a reasonable person that the market would turn bearish this year. That is the problem in general with predictions - they are usually extremely accurate only by looking at history ! However, this post is not to lambast people who attempt to time market cycles (some do get it fairly accurate but are often unable to repeat the "stellar" performance); but rather, it is a post to illustrate how one should take full advantage of a bear market to look for bargains.

I read, with some amusement no doubt, the views of various experts who were asked their opinions on the current market condition. There were varied opinions (as usual) ranging from the optimistic (the bear will only last 12 months and the market is also bottomed out) to the wildly pessimistic (we will get "buried" under a pile of earnings downgrades). It was all very amusing seeing people try to predict the market and to second-guess the economic environment and how long the current sub-prime crisis will last. The fact is that no one knows, yet everyone has an opinion and tries to make an "educated guess", in the process trying to sound intelligent and that they know exactly what's going on. I am not shooting down the opinions of famed investors; it's just that sometimes they should just admit they haven't a clue as to when this will end - I think that sounds more honest !

The beauty of a bear market will only be apparent to people who relish a bear market (usually value investors lah). Most other people see bear markets as something akin to the end of the world, depicting scenarios where people jump off buildings, declare bankruptcy and live the rest of their wretched lives in abject poverty. Such is the media spotlight which is thrown onto bear markets and the media's portrayal of such events. The doom and gloom can get so pervasive that you can hardly find much reason to cheer; in fact everyone is so enthusiastically predicting the end of the world that they fail to realize that opportunities abound to purchase cheaply. In fact, an investor's temperament should be the same regardless of whether the market is in bull or bear mode. He always has to emphasize margin of safety, as well as preservation of capital. Having such an attitude is important as it helps to minimize losses (this is in contrast to people who seek only to "maximize gains").

The Intelligent Investor by Benjamin Graham aptly mentions this point. Jason Zweig who wrote the footnotes for his book writes that without bear markets to bring valuations down to reasonable levels, no investor would be able to purchase with a decent margin of safety. Hence, bear markets are essential for investors and should be welcome with open arms. Bull markets are often dreaded by investors as they do not present suitable opportunities for investment.

That said, one must still be extremely selective in evaluating which company to invest in and to ensure that all aspects of the company are analyzed before a purchase is made. This is because in a bear market, everything looks cheap but the problem is that valuations may not actually BE cheap. During times of economic uncertainty and rising inflation, bear markets will usually occur. This has the effect of weighing on earnings of almost all companies and will throw their growth plans into disarray. Only companies which can pass on the higher costs or find a way around the difficulties will eventually emerge relatively unscathed. Thus, the "cheapness" of a company does not preclude one from investigative work to understand the nature of the business and whether it will be affected by higher costs and/or other economic factors. As a result, finding a worthwhile company to invest in can be a painstaking job and should not be considered simple.

Which is why Warren Buffett said that "Investing is easy, but not simple". The premise of investing is easy to understand, but the actual process to evaluate companies, churn numbers and to understand the workings of the economic environment and how it influenced a company are not simple. Therefore, every investor should work hard so that his/her rewards are well-deserved !