What Bears Can Teach Investors About Surviving Market Crashes

During their recent episode, Taylor, Carlisle, and Alex Morris discussed What Bears Can Teach Investors About Surviving Market Crashes. Here’s an excerpt from the episode:

Jake: Should we just do veggies? Yeah.

Tobias: Yeah.

Jake: Let’s do it.

Tobias: Let’s do veggies.

Jake: Let’s do it. All right. So, given that we are an investment related show, and that people seem to enjoy the veggie segments that are about animals the most, for some unknown reason, it’s surprising to me, at least–

Tobias: The sperm whales one.

Jake: The sperm whales, mostly. Yeah. It’s quite surprising to me that we’ve never done a segment on bears before. So, we’re going to fix that today. There are eight species of bear in the world. These include the American black bear, the brown bear, polar bear, Asiatic black bear, sloth bear, giant panda, Andean bear and the spectacled bear, which I had to look that one up. It’s in South America. It looks like a cross between a bear and a raccoon.

So, each species has adapted to its environment in different ways and leads to a very wide range of behaviors, diets, physical traits, etc. Bears are omnivores. As everyone knows, they eat plants and animals, and fruits, nuts, insects, fish, small mammals, the occasional human, but not too often.

Some species, like the polar bear, primarily eat meat. The giant panda mostly consumes bamboo, so quite the range. They possess remarkable physical strength. Grizzly bear can lift over 500 pounds, yet still run at speeds up to 35 miles an hour. So, basically, a bear could catch and eat Usain bolt while also lifting two and a half times his weight. So, it’s rather impressive.

Not all bears hibernate, but those that do, like the American black bear, can enter a state of torpor where their body temperature drops, their heart rate slows down to eight beats per minute and they could survive without eating, drinking or excreting for months. Of course, this is a crucial adaptation for when resources are low, typically in the winter. We’ll tie back into this a little bit later.

Bears communicate with each other with a variety of sounds, including growls, grunts, roars and even moans. I’m not sure you want to be around when that’s happening,-

[laughter]

-because they probably could have their way with you if they wanted. But they also use body language, like posturing and facial expressions, to convey messages to each other. Of course, they use pheromones to mark trees and signal their presence to other bears. Bears have an extraordinary sense of smell, like one of the best. It’s seven times better than even a bloodhound, which is pretty far off the charts. They can smell food up to 20 miles away, which is 21,000 times better than you and I, our sense of smell, and maybe even more than that if you had COVID and lost your sense of smell.

So, they’ve got excellent long-term memories. They can recall locations of food rich areas even after they haven’t been there for years. Of course, they come in a variety of sizes. The smallest is the sun bear, which weighs between 60 and 150 pounds, while Kodiak and polar bears can weigh up to 1,500 pounds. In the wild, they live typically for 20 to 25 years, but sometimes more. In captivity, they can live even longer with fewer threats and more regular food.

So, all this bear talk was inspired by a book that I reread recently by this financial historian named Russell Napier, who’s actually one of my favorites to listen to. It’s called Anatomy of the Bear. It was written in 2005. What he does is examine what it’s like in the heart of a bear market. Including he takes a bunch of clippings out of the Wall Street Journal and assembles them so you can put yourself into what the news flow felt like in real time during these historical periods when, obviously, none of us were around for probably the 1921 one.

So, he specifically looks at four different bear markets, 1921, 1932, 1949 and 1982. He chose those four, because they produced the best subsequent returns in the century. So, I figured it’s probably, psychologically easier to study bears while you’re still riding a bull, and before there’s something goes wrong, and you have something that’s super strong and fast scratching at the door.

I thought it’d be interesting, before we get into the anatomy of the bear, to explore a little bit of what Napier does is he gives you some context of what came up before the bear market started. And so, we’ll look quickly at the 1920s boom, and maybe give you some stuff that you didn’t know about that as an example of what’s in the book. So, specifically, he goes through the economy, the corporate earnings and the Dow in this case. Effectively, he’s teasing apart the changes in the underlying fundamentals and markets over the roaring 1920s.

So, I’ll give you some narrative with these numbers. Commodity prices actually fell a lot due to technical advancements and coming off of the highs of World War I demand. So, there was a lot of demand for really everything when you’re creating war material. So, the total value of mineral products, so basically, like all physical production during this 10-year span in the 1920s shrunk by 19%. But the total volume produced increased by 43%. So, basically, like, volume up but prices way down. This caused the wholesale price index to fall by 5% per year for the decade. So, imagine that. Your purchasing power growing by 5% every year. The Keynesian horror of it all. [laughs]

Real GDP grew 4% per year, which is quite good historically. What did that GDP look like? Like, what are we talking about? Basically, we all started really generating a lot of electricity, building houses, pumping oil, driving cars, smoking cigarettes and trading stocks. So, a little bit of like– Here’s the 10-year CAGR numbers for those things. Electricity production, 8% per year, which is a double over a decade. Housing starts 8%. Crude oil production, 10%. Vehicle registrations, 13%. Cigarettes produced 11%. Stock market volumes, 11%. Corporate earnings, quite strong at 7%.

But the enthusiasm for those earnings as expressed by the price of the Dow Jones industrial average was the fastest growing of all the data in the data series at a 25% CAGR from the 1921 low to the 1929 high. So, as always, people took something good, and then they extrapolated it too far. Interesting to note though, the government spending during that time period and public deck actually went down in the decade. I didn’t even know that was an option that we could do.

Tobias: [laughs]

Jake: All right. So, here are the seven hallmarks of these four generational bottoms that Napier explored. Hopefully, maybe this can help you to recognize if we find ourselves in another one. This is what the height of the bear looks like.

So, number one is cheapness. He references the Q ratio, which is basically looking at the price versus the replacement value of the assets. It fell below 0.3 times in all four of the bear markets that are studied. Basically, there’s a bunch of 30 cent dollars laying around. He also looked at the CAPE ratio, but it has a wider range. 4.7 in the low of 1932, 11.7 in the 1949 one. So, not quite as like definitive as like a 0.3. Equities become cheap slowly. This might surprise you. On average, it took nine years for equities to move from PQ ratio to trough. 1929 to 1932 is the outlier in that whole thing. Like, it moved really quickly there.

So, if you take that out like the other three, is more like 14 years on average to go from peak valuation to trough valuation. We really haven’t experienced a true grinding bear market that makes you want to hibernate for a decade. That has just not been any of our lived experiences so far. But that is what they look like in the wild.

Economic expansion continues even during a bear market, which might be a little surprising. Real GDP on average expanded by 52% over the course of those three long bear markets. Corporate earnings growth in real terms is relatively muted, but it does have a wide range, so there’s not much of a signal there. There’s a material disturbance in the general price level that’s a catalyst to reduce equity prices. So, it can either be inflation like 1982, or it can be deflation like 1921 or 1932.

This makes some sense and maybe were seeing some of that now, Alex, with some of your businesses, that if it’s rapidly changing the unit of account for a business, in commerce, it creates a lot of corporate uncertainty. Like, how do you enter into long term contracts when you can’t really trust the currency? So, maybe everyone starts pulling back and that then leads to economic slowdown. You’re like, when you mess with the unit of account with the currency, you get some unintended consequences.

This is obvious. All four bears bottom during economic recession, so the market is tied together with the economy. But what’s interesting is that prices stabilizing and especially the commodity prices and especially copper correlated with the eventual bottoms. So, once you got price stability, then things could start to go back to more towards normal.

In all four of these mega bears, the recovery in the auto sector specifically preceded recovery in the equity markets. So, I don’t know if that’s still true today, but a bit of a canary there. It’s a common misconception that its nothing but bad news at the bottom, but Napier actually shows through ample samples of these Wall Street Journal articles that the bear market bottoms– There’s an increasing supply of good economic news that basically just goes completely ignored by the market. It’s constantly good news even at the bottom.

And then, finally, many people believe that there’s a final big flush, like a capitulation at the bottom where everyone just throws in the towel and like, “Ah, I can’t do this anymore sell everything more to more.” But that’s actually not true. The market actually declines on very low volumes and eventually it starts rising again on higher volumes. So, anyway, hopefully, all this bear talk helps you get ready for a difficult stretch of track, which if were being historically informed, it’s really a matter of when, not if, we’re all going to have to deal with this again.

Tobias: If you look at some of the names, like Tesla, for example, topped out in 2021– When I look at the earnings for the S&P 500, they topped out. The top print is December 31, 2021, they’re up about 13% or 14% then even though the stock market itself was up 19% over that period. It feels to me like there’s a slowdown. I thought there was a slowdown last year that just didn’t get– wasn’t declared by the NBER, but there definitely was a slowdown. And now, we’ve maybe reaccelerated a little bit. Did you feel like we’re in one or is that–? What about the early 2000s? That wasn’t a long bear market?

Jake: He wrote the book in 2005, and he didn’t count–

Tobias: Too early to say.

Jake: Yeah. Well, too early to say that great returns came from that time period. So, that was why– He left 1973, 1974 out, for instance, all for that same reason. That’s fifth place, that would have been the next one to include in the book, he says. Especially, on a real return basis, you didn’t have good outcome even from 1973, 1974 for most investors.

Tobias: On a real basis, it was worse than 1929, right? 1973, 1974. That’s my understanding.

Jake: I don’t know if it was worse-

Tobias: Peak drop, anyway.

Jake: -but it was brutal. It was like one of those 70%, 80%. You got like 91% down in, or 89%, I think, in 1929 to 1932.

Tobias: He’s talking about stock market performance there too, isn’t he? So, when he says there’s no flush, like, there’s clearly associated with all of those– There’s been pretty big stock market crashes. It just happens at the start or what does he mean, there’s no flush?

Jake: I think it meant like huge volumes, like a flush at the bottom.

Tobias: Okay.

Jake: That was the flush part.

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