The million-pound question for stock market investors is whether to sell shares in a bear market or hold onto them in the hope that losses will stem.
When a company or stock index’s market valuation takes a tumble, it can be tempting to minimise potential losses by selling off shares and getting out quickly. But selling off shares is not necessarily the best approach, according to advisers.
Bear market sell-offs exacerbate the bearish trend and plunge stocks even lower. The opposite effect is a bear market rally, where investors buy shares in falling stocks, expecting the price to rise.
“What no-one wants to do is panic out and sell at the bottom, as that locks in losses and crystallises them,” said Russ Mould, investment director at AJ Bell.
He said the only sensible policy for any investor is to stress test their portfolio, and check it fits in with their investment strategy, time horizons, target returns and appetite for risk.
Holding onto shares during a downturn or negative growth does have the potential to create an upside, though it can be a risky strategy.
“Cross-check that with company valuations, based on book value or mid-cycle earnings (so historic figures, not perennially optimistic analysts’ forecasts) and you might then be on to something,” said Mould.
The S&P500 index of US company stocks trod into bear territory this June, after losing more than 20% of its value in six months.
A stock market sell-off in the Dax in Germany this week meanwhile pushed the index down slightly as investors responded to uncertainty over rising interest rates and monetary tightening by exiting shares.
“The DAX in Frankfurt lost 2% amid a broad-based sell-off,” said market analyst Neil Wilson.
Whether the FTSE will similarly experience a sell-off is a question no one can answer without a crystal ball, said Mould.
The FTSE250 index is looking bearish, losing 21.7% of its value during the year to date, while the premium FTSE100 listing has suffered minimal losses this year.
Whether to hold or sell shares depends largely on investors’ circumstances.
“If they fear there is further downside and they may need the money quickly it may be best to build up a cash buffer and take less risk,” Mould said.
“If they think the bottom is nearing and they can afford to take a very long-term view, and ride out near-term falls, they may be seeking to average into the market and take advantage of weakness.”
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Bank of America (NYSE:BAC) Merrill Lynch said this month that it expects the US stock market to recover by October 19, based on data from previous bear markets.
Bear markets typically take an average of 289 days from peak to trough with average declines of about 37.3%.
SEI Investment Management Corp and Yardeni Research similarly predicted that the US could be over the hump of the bear market.
After spending 160 days in a bearish trend, the SEI said the US stock market was more than halfway through the median length of a downturn.
In an analysis of just how much earnings could fall amid the bear market in the US, investment bank UBS said that if growth slows but a recession is averted, it expects its average earnings per share forecasts for the S&P 500 of $235.5 for 2022 and $250 for 2023 to be achievable.
However, UBS said that based on its top-down model, earnings growth is due to slow from 8% this year to 4% in 2023 as gross domestic product figures slow and cost pressures “remain”.
“If you’re looking for signs that the bottom is near, then a near-total absence of people asking if the bottom is in and whether it is time to buy is one,” said Mould.
Recession stocks
The game-changer would be if the market heads into a recession.
Earnings per share declines following the 2007-8 financial crash on the S&P 500 (trailing) hit 53%, compared to just 27.3% at the dot-com bubble and 20.9% after the pandemic in 2020, UBS figures show.
Some of the greatest declines after the financial crash were in earnings at financial companies and consumer discretionary goods companies, according to UBS data.
They suffered tumbles in earnings per share of 130.9% and 109.9% respectively, while real estate earnings took hits of 81.8% following the subprime crisis.
Much of the shape of the trough depends on the nature of the downturn. For example, technology suffered EPS hits of 123.2% in the dot-com bubble from 2000 to 2003.
Consumer staples and healthcare proved to be relatively defensive stocks through the last few downturns, according to UBS data.
These sectors experienced losses of up to 17.3% after the dot-com bubble, with trailing earnings in staples suffering just 7.2% after the financial crash. Healthcare losses were 8.8%.
“There are many stocks out there with a lot of debt, not much by way of pricing power or that still trade on very lofty multiples of peak profits,” said Mould.
“If the economy tanks and takes their profits with it, they might offer a lot of potential downside in exchange for much less upside, at least right now.”