Bear markets are terrible for permabulls who just buy and hold forever. The stock market tanks 40%+ and it takes years for the stock market to recover to its previous all time high. During those years these permabulls are underwater with massive losses.
However, bear markets are good for savvy long term investors and traders who know what they’re doing. Bear markets yield massive profits for investors and traders who can predict the bear market and predict the start of the next bull market. Every crisis is an opportunity, and bear markets are huge opportunities. Here’s why.
The first rally of a new bull market rally is always very fierce
Mean-reversion states that when you stretch an elastic band too much in one direction, it will snap back very fiercely in the other direction.
This means that after the stock market crashes in a bear market, it will rally like crazy in the first leg of a bull market. This first rally will yield massive profits for investors and traders who can catch the bear market’s bottom with a reasonable degree of accuracy.
Here’s the first big rally after the 2007-2009 bear market. The S&P soared 83% from March 2009 – April 2010, a mere 13 months!
Here’s the first big rally after the 2000-2002 bear market. The S&P soared 47% from March 2003 – March 2004, a mere 1 year!
Here’s the first big rally after the 1973-1974 bear market. The S&P soared 60% from October 1974 – July 1975, a mere 9 months!
Here’s the first big rally after the 1968-1970 bear market. The S&P soared 52% from May 1970 – April 1971, a mere 11 months!
As you can see, bear markets are followed by very fierce rallies over a relatively short period of time. So you will achieve massive returns if all you did was buy $SPY (S&P 500 non-leveraged ETF) at the bottom of the bear market and held it for 1 year. Post-bear market rallies can be very choppy on a day-to-day basis, but the overall uptrend is very strong and persistent.
Leveraged ETFs compound like crazy during the first leg of a bull market rally
Leveraged ETFs lose value to erosion when market is very choppy and has many pullbacks. Leveraged ETFs compound on themselves when the market’s trend is very strong.
This means that when the market is rallying in a very strong trend without big pullbacks/corrections, the leveraged ETF will go up more than the amount of leverage it has.
For example, let’s assume the S&P 500 goes up 50% in the first post-bear market rally. This rally is very strong and there aren’t many corrections along the way. A 2x leveraged ETF won’t go up 100% – it’ll go up more than 100% (maybe 150%). A 3x leveraged ETF won’t go up 150% – it’ll go up more than 150% (maybe 250%). That’s just how compounding works for leveraged ETFs.
So the first rally after a bear market is extremely lucrative for leveraged ETF traders and investors. The stock market’s rally is very fierce. And because the rally is very persistent, leveraged ETFs compound like crazy and deliver massive returns to bullish investors and traders.
Bear markets cause stocks to become undervalued
By definition bull markets cause stocks to become overvalued and bear markets cause stocks to become undervalued. The more undervalued a stock is, the better of a long term investment it becomes.
This is particularly important for dividend investors. The problem with dividend investing is that capital losses from bear markets will completely overwhelm whatever dividend a company pays. For example, a 4% dividend is already considered to be “very high”. The stock market can fall -50% in a bear market, which makes the 4% dividend look like chicken scratch. This means that buying and holding a dividend stock isn’t worth it during a bear market.
But buying dividend stocks at the bottom of a bear market is a good idea.
- You stand to gain from the increase in the stock price when the bear market ends and the next bull market begins.
- The stock market’s downside is limited because the market is already undervalued. So even if the stock swings sideways, investors will still earn money from the dividend. This is akin to buying a long term bond that pays a decent yield. The bond (dividend stock in this case) doesn’t lose much value, but it continues to throw off a healthy yield to investors.