There’s a risk that investors learn the wrong lessons from recent market cycles. One of the biggest wrong lessons is that the market always quickly recovers.
Of course, quick recoveries have defined the stock market since the 2008 financial crisis. The 2009 bottom led to the longest bull market ever and the buy the dip mantra (BTFD) grew from that period. The 2020 crash solidified it.
It would come as no surprise if investors expected recent history to repeat itself. Of course, investors often mistakenly rely on recent history or lived experience to make decisions, as if it’s the only history that matters.
In fact, Seth Klarman noted this specific false lesson in 2010:
Bad things happen, but really bad things do not. Do buy the dips, especially the lowest quality securities when they come under pressure, because declines will quickly be reversed.
Howard Marks shared a similar thought in his book Mastering the Market Cycle:
I fear that people may look back at the decline of 2008 and the recovery that followed and conclude that declines can always be depended on to be recouped promptly and easily, and thus there’s nothing to worry about from down-cycles. But I think those are the wrong lessons from the Crisis, since the outcome that actually occurred was so much better than some of the “alternative histories” (as Nassim Nicholas Taleb calls them) that could have occurred instead. And if those incorrect lessons are the ones that are learned, as I believe they may have been, then they’re likely to bring on behavior that increases the amplitude of another dramatic boom/bust cycle someday, maybe one with more serious and long-lasting ramifications for investors and for all of society.
A quick market recovery is one possibility in a wide range of outcomes after every bear market. Had events played out differently, the 2008 financial crisis could have been significantly worse than it was. The same is true of the 2020 crash. An alternate history exists where BTFD never becomes popular.
Except, that’s not what happened. The bull market lasted longer than anyone expected, many investors believe BTFD is a strategy (it’s not!), and the fear of missing out on the recovery will drive their decisions because they failed to look beyond 2008.
Since 1929, the average bear market (peak to trough) lasts about one year. But the average leaves out some context. The shortest bear market was in 2020, lasting 32 days. The longest was the 929-day stretch that wiped out the Dotcom Bubble. That’s 2.5 years to hit bottom. That range — 32 to 929 days — offers an idea of how long the current and future bear markets might last but they’re not limited by the past.
More importantly, not every ensuing market recovery can be defined as “quick.” In fact, the market can experience fits and starts that drag on for months or years after it bottoms before resuming its long-term upward trend.
In investing, hindsight is often the worst teacher and we’re blind to the future. Every bear market rally looks like the start of the next bull market. Every bull market dip looks like the start of the next bear. The reality is we won’t know when the bear market ends until we’re well into the next bull market.
Buying only because the market has fallen is not how to invest. Buying because the market has gotten cheap is a reason to buy. The same is true for stocks. An investor who can’t differentiate between the two is trying to time the market.
Trying to guess which rally or dip marks the turning point in the market is the wrong way to approach things. Market timing doesn’t work. You’re better off holding on the entire time than trying to jump in and out of the market.