A tale of 2 bear markets


I have a confession to make.

Along The Path to financial independence, The Escape Artist made plenty of mistakes, including the occasional cluster-fuck.

Here is the story of how I screwed up in one bear market and learned the lessons to make money in the next one.

In bull markets, investors often become complacent. As someone smart once said: it is only when the tide goes out that we see who has been swimming naked.

It is in market crashes that fortunes are lost by forced sellers. In those same market crashes, fortunes are made by those with the mental and financial resources to buy.  

The Escape Artist has been around long enough to have seen a couple of full scale bear markets up close.  In 2000 – 03, the FTSE All Share fell approximately 49% and then by some 45% between 2007 – 09, peak to trough.  I learnt a lot about risk, investing and my own character from those two episodes.

Bear market #1 : 2000 – 03

The equity markets in the US and UK peaked around the turn of 2000 amid the champagne corks of millennial celebrations.  At its peak, the US market traded on a Shiller PE of about 44x versus its long run average of about 16x, implying it was approximately 2.75x overvalued.

Those were dangerous times.  I remember the Sunday Times introduced a column “Diary of a Day Trader” which told the story of an insurance middle-manager who had quit his cubicle job to day-trade stocks.  That guy was not financially independent and had no edge other than he felt lucky, like the punk in a Dirty Harry film.  As always with day-trading, it did not end well.

I mostly avoided being sucked into the bubble in tech company shares of the time.  Lastminute.com, COLT Telecom, Freeserve and ARM were some of the highest profile in the UK at the time.   I remember my elderly godmother, not normally given to gambling, telling me that I couldn’t afford NOT to have some ARM shares as they headed for the sky.  If this isn’t a sell sign, I don’t know what is.

There is nothing more disconcerting than seeing people around you getting rich doing dumb things.  Fortunately my financial conservatism kept me clear of the worst offenders although I confess to having some (ill-fated) Marconi shares and some Celltech shares (later taken over at a healthy profit) at the time.

In 2001, early in the bear market, I had a lightbulb moment.  If a stock was never going to pay a dividend, then it wasn’t worth anything to me.  Yes, I know that some valuable stocks (eg Berkshire Hathaway) choose not to pay a dividend.  But that is very different from a company that is never going to pay a dividend because it can’t generate the surplus cash to do so.

I learnt from textbooks that the value of a share (P) is equal to the present value of the future dividend stream accruing to the shareholder.  The formula is this:

               div t+1

P         =        __________

               r – g

Where: div t+1 is the next annual dividend

r = the required rate of return or discount rate

g = the assumed rate of future dividend growth

Whilst I don’t use this formula to value stocks (it requires making long term forecasts which are unreliable), it reminds us that value results from cash generation and dividends paid out by companies.

My lightbulb moment came when I looked at the stocks in my portfolio and realised that a couple of them I never expected them to pay dividends in the foreseeable future.  I was holding them in the hope that someone would come along and take them off my hands at a higher price. This is known as Greater Fool Theory.

I immediately sold everything that did not pay a dividend.   With this simple rule, I avoided the worst of the tech carnage.  This became known as the 99% club as these stocks lost almost all their value.  But the losses were not confined to tech.  As 2001 rolled into 2002 and 2003, the whole market kept grinding lower.

Some personal context is relevant here.  In 2000 our first child had arrived and we lost the second income.  We still had a mortgage then.  In 2002, I changed jobs. Whilst it looked like a step up, I quickly realised that I didn’t like the new job.  This was where the benefits of FI became glaringly apparent to me. What should just have been a career hiccup became a personal financial crisis.

My investment portfolio had previously exceeded the value of the mortgage, which I had been focussed on paying down. During the bear market, the value of my portfolio ground lower.   I tracked its value versus the amount of my mortgage.  Psychologically, this was agony to watch.   I couldn’t avert my gaze, like watching a train crash play out in slow motion.  What made it intolerable was the thought of losing my dream of clearing the mortgage and living debt free.  With hindsight, I should have just stopped watching the screen.

The Iraq war was approaching. The world looked scary.  There is no polite way to say this – I was crapping myself.  I finally capitulated in March 2003.  I sold every stock I owned.  I took the proceeds and cleared the mortgage.  At the time, it felt like the prudent course of action.  In retrospect, it seems like treating a finger cut by chopping your arm off.

Timing is everything in market cycles.  My timing was impeccably bad.  I sold everything within a couple of weeks of the market trough.  I then got to watch many of “my” stocks recover over the next 2 years. Unfortunately, I watched this from the sidelines, sick as the proverbial parrot.

I had allowed myself to become a forced seller. Firstly I was leveraged (the mortgage). Secondly, I allowed an arbitrary portfolio value to become a stop loss level. The problem with stop losses is that market volatility has an annoying habit of stopping you out, even when your position was sound.  Thirdly, I ended up selling without a rational comparison of price versus value.

Bear market #2 :  2007 – 09

2000 – 03 had been about correcting overvaluation in the market.  At no point was the capitalist system itself in danger. In contrast, 2007 – 09 was a systemic crisis.  As George Dubya said: “this sukka could go down”.

After Northern Rock failed, being a contrarian with a fertile imagination, I didn’t find it too hard to imagine a doomsday scenario in which the entire banking system was pulled down by an old-fashioned series of runs on the banks.

Months went by and my nightmare scenario seemed to be playing out. The day after Lehman went down I remember the eerie feeling of walking around London wondering why more people were not panicking.   I started to hear rumours of deposit withdrawals from even the largest banks.  Why were all the leveraged hyper-consumers not flipping out?  Did they not realise that Judgement Day was coming?

The equity market plunged.  For a brief period, the greatest bargains in the equity market were the liquid, high quality names. Desperate funds had to sell to raise cash and the only stuff finding a bid was high quality stocks.

I sold all my small cap stocks. Ironically, in the early stages of the panic it was possible to get out of these without too much pain.  It was as if in the mayhem the market-makers were more focussed on the trading action in large caps.  I sold small cap risk and added large cap quality aggressively.  I bought the highest quality, large cap companies that would be the last ones standing after a possible Great Depression.  Meanwhile, I directed my pension contributions 100% to equities via a low cost global equity index tracker fund.  It was scary but I held my nerve and added equity exposure all through the autumn and winter of 2008.

Buying more equities seemed a one-way bet at that point, akin to Pascal’s Wager. Either the whole capitalist system would implode and equities would be worthless (along with bonds or cash) or it would survive and I would ride the recovery.  In an end of capitalism scenario, there would be no point holding any financial assets anyway, only shotguns and tinned beans would be worth having.  The system did what it has always done and scraped through.

The key difference between the 2 episodes was mental.  In 2008 I was debt free, held better quality assets and was prepared to ride out the storm.  I had learnt my lesson from 2002 – 03.  As the market recovered in the years after 2009, my portfolio did very well.

Bear markets are the friend of the long term investor. If your supermarket temporarily marked everything down by 50% you’d respond by stocking up. Why should investing be any different?

I’ll leave you with this: stockmarket volatility is like a rollercoaster. If you stay strapped in, its harmless fun. But if you get out halfway through the ride, YOU’RE SCREWED.



Financial Coaching




  1. Great post.

    There are some familiar names in there from the turn of the millennium, Durlacher the ‘dot com incubator’ was the one that most sticks in my mind from that period. I remember thinking (pre crash) I’d missed the boat and calculating how rich I would have been had I been ‘tipped off’ earlier and punted part of my student load (as I was doing on other shares at the time). Thankfully I decided against piling in just days before it crashed, unlike an unlucky colleague of mine.

    Thankfully that time coincided with my third year at University so most of the profits I made on the boom were quickly recycled into the student union bar before I could lose them! That said my Yell.com shares didn’t buy me many pints when i eventually sold them!

    I think you sum it up perfectly when you say that “there is nothing more disconcerting than seeing people around you getting rich doing dumb things”. It’s all too easy to forget that it is exactly this herd mentality that causes this constant cycle of boom/bust. Our natural fear of exclusion and our greed for an easy buck are powerful forces that are all too easy to succumb to.

    1. Ha! Yes I do remember Durlacher. I remember meeting a HNW individual around that time (c.2000) who owned about 20% of the company. I cant remember the exact numbers but on paper he was “worth” about half a billion pounds…for a couple of months & before it evapourated like a pixies dream….I wonder how much he took off the table?!

  2. underthemoneytree · · Reply

    I can’t remember who told me about Durlacher at the time, but it was pitched to me as follows:

    You see all these people getting rich of dot com companies. If you buy Durlacher it’ll be like dot com riches squared

    A great sales pitch, but terrible advice!

    Crikey, I hope he/she managed to keep hold of some of their NW when the pixies woke up. If not that’s the sort of error that would seriously haunt you.

  3. Exactly! I am looking forward to the next bear market, whenever that will be. What a great way to improve yields. We buy goods when they’re on sale. Why the stock market is a different story to most is beyond me. Bring on the “red tag deals”. I’m ready when they are.

    1. Yes, agree that makes sense. I think the trick is to know at what level you will buy at. Otherwise there are are a couple of traps:

      1. When the market falls, some people keep holding off hoping it will go lower…and never pull the trigger

      2. When the market falls, assuming it’s because the world has got riskier…and then getting nervous and not pulling the trigger

      I’m not suggesting you will fall into these traps…but they are common thought processes

  4. Well the markets seem to be in free fall this week so a very relevant post for me to happen upon 🙂

    Expanding on your points to F2P above is when do you buy? If you are earning and just ploughing as much in every month then it’s business as usual but if you are sitting on some cash then I guess the question is much trickier

  5. So what’s your plan for the next downturn?
    If, as seems likely, we’ve now exhausted the central bank bullets and this debt has to be paid down or defaulted on – where will that take us?
    Are we turning Japanese (post 1989) and will it take 25 years to reach the bottom?

    1. My plan for the next downturn is: 1. Not to panic 2. to continue to collect my dividends and 3. hopefully re-balance towards my target asset allocation by buying more equities as they get cheaper.

      In 1989 the Shiller P/E on the Japanese market was ~ 90x…an obvious bubble…we are nowhere near that level now.

  6. […] For a great real life example in what I’m talking about here check out TEA’s tale of two bears. […]

  7. […] even if you’ve discovered your account balance has been cut in half, in a historically savage bear market, then things are not nearly as bad as they […]

  8. […] the early noughties, a prolonged market decline steadily turned British investors against stocks (despite the magic opportunity) and further […]

  9. Gosh, I barely remember the 07/08 crash – that was pre-earning years for me. The recent downturn this February was my first experience of a bear. I did stick to my guns and continue piling more money into my investments though!

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