The odds of a bear market

Recently, I decided to relax from my very hectic RRSP paced business. I would go home on a Friday night and instead of working on the computer, I would order a pizza, watch some mindless TV and go to bed early.

Nice try! I wound up watching three hours of ROB TV listening to economists, mutual fund managers and other experts give their opinions on the reasons markets do what markets do. There are a few things I learned from my Friday night:

  1. It’s easy to analyze the past. Most of the experts and media celebrities can tell you exactly why Nortel dropped, why the markets are so volatile and why the economy is the way it is. Hindsight is really easy, but it still does not tell us anything about the future. Reading the newspaper, watching television and keeping informed is very important, but we need to understand that most of this information is old news. Be very careful about how you apply old news to the future.
  2. When it comes to the future, none of the experts can agree. Among the experts, there were bulls, bears and everything in between. Each had their opinion on the future but yet, there was no consensus. In fact, I question whether there is ever consensus. I counted, out of 8 experts (2 economists, 3 mutual fund managers, one quantitative expert and 2 others) we had 4 pessimists, 2 optimists, and 2 neutral opinions. If you count my opinion, that would make it a total of 9 differing opinions.
  3. Predicting the future is impossible. The markets are a sum of buyers and sellers and a number of varying opinions. Just when you think you’ve got the market figured out, it changes and the rules change. This is precisely why experts feel the market timing is so foolish. Accept the fact that markets in the short term are random movements. Market predictions cannot be done with any degree of accuracy.

Try this exercise. For the next 15 business days (three weeks) try to predict where the markets are going to go the following day. To keep it simple, all you have to do is predict whether it will go up or down (you need not worry about how much). The chance of you getting all 15 days right is less than 1 in 33000. To put this in perspective, you have a higher chance (1 in 9000) that the Earth will be struck by a huge meteor during your lifetime.

Odds of bears looming

Since we are on the topic of odds, what are the odds of market drops? I recently came across some research by the Capital Research and Management Company on the frequency of market drops:

  • Drops of 5% or more occur 3 times per year
  • Drops of 10% or more occur once per year
  • Drops of 15% or more occur once every 2 years and
  • Drops of 20% or more occur once every 3 years.

So what’s my point?

Here’s what we really know about the future:

Firstly, markets go up and down in the short term. What we are experiencing today is simply a reality of what happens from time to time. Although we hope the markets are invincible, today is a living reality that they do not go up all of the time.

Also, given a little patience, markets will go back up. We do not know exactly when, but we know they will reach their previous highs and go higher. Take comfort in history – the stock market has crashed several times before – notably in 1929, in 1973/74, in 1987 and 1998. Each time it has regained strength and gone on to new highs.

This RRSP season, I have talked to many investors who have been burnt in the recent market downturn. Many are looking for answers to undo the past and also for some advice for the future. My best advice is a little common sense – have a little patience because markets will eventually go up, don’t try to time the markets and never make the same mistake twice.

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