When investing in companies, we as investors should always be attuned to the general sentiment in the market, as this would influence overall valuations and allow one to assess if a company may be over or under-valued.
The famous investor Howard Marks describes market sentiment as a “pendulum” which swings from one extreme to the other, hardly ever resting in the middle. This is because humans tend to over-react on both extremes, and we end up seeing valuations over-shooting in both directions, making stocks routinely either too expensive, or dirt cheap. When it comes to overall sentiment, we use the terms “bear market” and “bull market” to signify bad times and good times, respectively. Let’s focus on what a bear market is in this article.
A bear market is defined by Investopedia as such:
“A bear market is a condition in which securities prices fall and widespread pessimism causes the stock market’s downward spiral to be self-sustaining. Investors anticipate losses as pessimism and selling increases.”
The key words here are “pessimism,” “spiral,” and “self-sustaining.” Bad news causes pessimism in investors, who then proceed to sell their shares as they feel that the future outlook is bleak and that companies will not be able to grow their revenues and earnings. The wave of selling then causes share prices to fall sharply, which contributes to a downward spiral. When other investors see these sharp price declines, they take it as a cue to sell as well, thus exacerbating the sell-off and causing the selling to be self-sustaining.
This vicious cycle will continue to perpetuate itself until all sellers have managed to exit the market, at which point valuations will be at their nadir as share prices fall far below what fundamentals would dictate to be reasonable.
As investors, we should remain calm during bear markets and look for golden opportunities to pick up shares in great companies at cheap valuations. Bear markets provide fertile opportunities for investors to scoop up shares at rock-bottom prices. However, fear and uncertainty will always rear their ugly head in investors’ minds and cause both hesitation and anxiety. It is important to have a disciplined approach to sifting out good bargains as well as a strong stomach to buy when everyone around you is selling.
In a subsequent article, I will look at characteristics of a bull market and how to position one’s portfolio defensively in such a scenario, in order to minimize losses in case a downturn hits.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.