Client Letter – Q3 2002

The 2000-2002 bear market, which has lasted over two years, has scared many investors. The market’s steep declines are scary, but a long-term view can ease some of your anxiety.  There is no question that the market can be very risky in the short run.  That is why you should never invest money in the stock market that has a time horizon of less than five years.

The chart below shows the total returns of nine asset classes over three different periods of time.  The second column focuses on the entire bear market period (the last 25 months), while the last two columns show the returns for the most recent one-year period and three-month period.

Market Returns for the period ending September 30, 2002

Asset Class 25-Month Total Return One Year Return 3 Month Return
U.S. Large (S&P 500) -44.7% -20.5% -17.3%
U.S. Large Value -10.1% -10.3% -19.7%
U.S. Small (Micro) -17.6% -1.1% -20.7%
U.S. Small Value 0.7% 2.3% -22.7%
Real Estate (REITs) 26.3% 8.2% -8.2%
International Large -40.9% -14.6% -18.8%
International Small Value -5.7% 5.1% -11.8%
Emerging Markets Large -32.6% 3.8% -14.6%
Five-Year Global Bonds 18.7% 9.1% 5.3%

As you study the chart (take 5-10 minutes at least), you should consider the following points:

  • In terms of both length and depth, the current bear market is now the most severe since the Great Depression (when the S&P dropped 80% over 27 months).
  • During the entire bear market period, several asset classes (such as U.S. small stocks, real estate, and bonds) have still had positive returns.
  • The asset class returns for the last year (column 3) looks much better (except for the S&P 500) than those of the last three months. This is because the markets did quite well during the first 6-7 months following the 9/11 attacks, but they started to do poorly again in mid 2002.
  • During the last three months, the returns were negative for every asset class except bonds. Even real estate did not escape (even though it dropped less than the other asset classes).  As I’ve said before, the only asset class that you can depend on to protect your portfolio during a bear market is bonds.  This is why the primary risk/return decision for any investor is determining what percent of their portfolio should be in bonds versus stocks.
  • The value of diversification among asset classes is more visible over longer periods of time. There can be short time periods (such as the last three months) where almost every asset class does poorly.  However, over longer periods of time, the performance of different asset classes varies dramatically.

History suggests that those who commit for the long haul have a much better chance of avoiding loss and of making money. Hundreds of years of stock market data show that the longer the time frame, the lower the swings from up to down and the less chance of loss. For instance, in the postwar period the S&P 500 has suffered 12 annual losses, ranging from a decline of 1% in 1953 to a loss of 26.5% at the depths of the bear market in 1974.

Investors who stretched out their time in the market saw their risk of loss decline and the level of loss drop substantially. There were only two five-year periods where investors lost money on an annualized based. Those who started investing in 1970 and went through the bear market lost 2.4% per year; those who began in 1973 and suffered through the bear lost just 0.2% per year over the next five years. The story gets better as time goes on. Over every 10-year period an investor always made money, despite bear markets like 1973-74. The worst annualized return was 1.3% per year for investors who got into the market in 1965. Those who stayed in for 15 years fared even better. Once again there were no losing periods and just one where the annualized return was less than 6%. Investors who began buying stocks in 1960 got a 4.3% annualized return over the next 15 years. Finally, the 20-year returns are very respectable. The worst annualized return was 6.5% for someone who started in 1959. At that rate, $10,000 grew into $35,435 over the period.

So, the secret to surviving this bear market (emotionally) is keeping a “big picture” perspective.  I have no doubt that the bear market will end someday.  And like you, I hope the end comes soon!  If history is any guide, you will be generously rewarded for your patience and discipline.

If you are concerned about how the bear market has affected your financial plan, please call me so that we can talk about it.  Also, please feel free to call if you have any questions about your portfolio performance reports.


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About Christopher Jones

Christopher Jones is the Founder and President of Sparrow Wealth Management, a fee-only financial planning and investment management firm. Before entering the investment field, Chris was a management consultant for Deloitte Monitor. He graduated summa cum laude from Brigham Young University with a B.S. in Economics and a minor in Business Management.