Investing Near the End of a Bubble Can Be Tricky, But Patience Pays Off

In the last ten market down cycles, investors who entered the market at the initial price discount usually underperformed those who bought later.

Michael Nagle/Bloomberg

Michael Nagle/Bloomberg

When it comes to investing during a market downturn, earlier isn’t always better.

That’s because stock market bubbles usually don’t burst right after the initial price decline, according to the latest study from Richard Bernstein Advisors. The Nasdaq 100 index, for example, sank 83 percent during the crash in technology stocks, which lasted from March 2000 to October 2022. But over the course of those 31 months, the index also saw 16 rallies above 10 percent, including three rallies exceeding 30 percent, according to RBA.

“Bubbles don’t deflate overnight,” Dan Suzuki, deputy chief investment officer at RBA, wrote in the study. He added that investors tend to add discounted stocks to their portfolios instead of selling them at the beginning of a market down cycle. But such assets don’t generate excellent returns for at least the next six months.

To prove his point, Suzuki referred to a previous RBA analysis about stock market returns during historical market downturns. For each of the last bear markets, the researchers studied the return data six months before and 12 months after the market hit the bottom. They found that 70 percent of the time, those who invested after the market troughs earned more than those who invested at the beginning of the down cycle.

“Not only does [investing late] tend to improve returns while drastically reducing downside potential, but this approach also gives [you] more time to assess incoming fundamental data,” Suzuki wrote. “Because if it’s not based on fundamentals, it’s just guessing.”

The only exceptions in which early investors outperformed were in 1982, 1990, and 2020. But Suzuki noted that these were periods during which the central bank had already been cutting interest rates before the market turned bearish. “Given the high likelihood that the Fed will continue to tighten into already slowing earnings growth, it seems premature to be significantly increasing equity exposure today,” he wrote.

The fact that not all companies will flourish throughout different market cycles is also part of the reason why investors should avoid buying discounted assets, according to Suzuki. He added that bear markets usually signal that it’s time for new leadership to replace the older one. “Thus, this year’s sell-off has been the market’s way of trying to hit investors over the head with the idea that they should avoid clinging to yesterday’s winners,” he wrote. “[Unfortunately,] few seem to be listening.”