The question that seems to be on every investor’s mind is “When will the stock market stop falling?”

I can’t tell you how many times over the past few weeks I’ve heard market strategists share their views on when the stock market will bottom out. I am always amazed that people think you can predict when the stock market will stop falling. I often wonder if the interviewer really believes that the market strategist really knows.

Wall Street is littered with predictions that have never come to pass. Why should we believe the soothsayers now, after they failed to predict the extent of the housing bubble and subsequent credit crisis? If anyone tells you they did predict this bear market, tell them to show you their brokerage statement, which should reflect their great market call.

Investors seem to want someone to tell them the date or the price level, which is impossible to predict. In a down market, regardless of how cheap a stock appears, it can always become cheaper. When trying to pick a stock market bottom or top, one is trying to figure out the unknown as well as attempting to measure the extent of fear or greed in the market — a task that is very hard to do.

When I’m asked about when I think the stock market will stop falling…I don’t even try to guess. Since I don’t have a crystal ball, anything I see would just be another prediction.

Since I view buying stocks as buying pieces of a business, my concern is how the business is doing and not what the current stock price is. If I buy pieces of great businesses at attractive prices and hold them for the next few years, I couldn’t care less if they closed the stock market. I do not become distracted by Mr. Market’s manic-depressive outbursts as he offers stocks at extremely low prices.

The Guessing Game

I recently heard someone say how obvious it was only six months ago…when “everyone” knew that the stock market was going down because of lower crude oil prices and a downturn in China, to sell their stocks and wait to buy them back when the “future was clearer”.

Think for a moment: when was last time the future was clear?

By definition, the future is unpredictable and never clear or certain. Events appear obvious only when you look back on them from the present; as the saying goes, hindsight is 20/20. Investing based on guessing what the future will be is a game that I can’t and won’t play. In Buffett’s letter to his partners in July 1967, he wrote:

We will not sell our interest in businesses (stocks) where they are attractively priced just because some astrologer thinks the quotations may go lower even though such forecasts are obviously going to be right some of the time. Similarly, we will not buy fully priced securities because “experts” think prices are going higher.

Warren Buffett

Buffett then recommended that if the stock market becomes very extended to either the downside or the upside, one should take advantage of it: buy stocks when they are at low prices and sell them when they are at high prices. Sadly, most investors do the exact opposite: they sell when prices are low and buy when prices are high.

While I have no clue as to when this bear market will end, I do know one thing for certain: this too shall pass. Unfortunately for those who are waiting for the all-clear sign, the stock market does not ring a bell at the bottom and tell you when the coast is clear. From studying previous bear markets, there are two things we can learn about bear market bottoms: (1) they usually don’t end with a selling climax and (2) the stock market turns higher well before the economy does.

Lessons Learned

What can we learn about bear market bottoms, and how can we apply it to what we are seeing now?

1. You will never pick the bottom. If you think you can try to pick the exact bottom, you are fooling yourself. By trying to pick a bottom, you are trying to make sense of the stock market’s random price swings on a short-term basis. No one can consistently predict those turning points with any degree of accuracy.

2. A bear market usually ends with a whimper, not a bang. Indicators such as double bottoms, testing of previous lows, and other technical factors prove to be false. Eventually stocks become so cheap relative to the underlying worth of the business that investors begin to recognize their value and start to buy.

3. Economic and political news continue to be negative. The news flow and negative sentiment continue to roll on for several months after the stock market reaches a bottom. Positive economic reports and a more certain political climate usually occur well past the stock market low.

4. Each bear market has its own problems. While there are differences between the problems the economy and markets face in each bear market, they all have one thing in common: the solutions seem to be in the very distant future. “Each crisis is characterized by its own new set of non-recurring factors; its own set of apparently insoluble problems; and its own set of apparently logical reasons for well-founded pessimism about the future” (“Successful Selling Against the Tide.” Capital International Funds, November 7, 1974).

5. Sitting out will cost you. If you wait until the stock market settles down, you will miss a good part of the up move. By the time fear is replaced by greed in the stock market cycle, most of the gains have already been made. During the worst point in the Great Depression, the DJIA closed at 41 on July 8, 1932, slightly above where it started in 1896.

Yet less than two months later, the DJIA was up 79% from its low, and one year later it was up 151% from the low. Powerful rallies are the rule, not the exception, at the end of a bear market. For example, on August 12, 1982, the DJIA made a low of 777 and less than four months later was up 33%.

What Works

Since we have already concluded that during a bear market we can’t pick a bottom, when should one invest in stocks in the face of falling prices and extreme pessimism? There are only two choices: invest when stock prices are declining and be too early, or invest when stock prices have begun rising and invest too late.

Much smarter investors than you and I have tried both approaches with poor results. It seems that both approaches, too early and too late, have the same drawback: paralysis.

When prices are falling, investors fear further declines and allocate only a small percentage of their assets to stocks. They do this because they feel they can always buy stocks cheaper or they don’t want to show a loss in their brokerage accounts. On the other hand, when prices are rising after a bear market bottom, the fear of leaving the safety of cash makes it very difficult to begin purchasing stocks.

The best possible solution is to have a plan of buying well-managed companies with strong balance sheets that have solid earnings and little debt, when they are selling at fire sale prices. The key is to purchase the unloved and unwanted when they are being given away. The bargain price you pay will be the margin of safety against short-term wiggles in the economy.

Warren Buffett said, “By buying assets at a bargain price, we don’t need to pull any rabbits out of a hat to get extremely good percentage gains … Have the purchase price be so attractive that even a mediocre sale gives good results” (Letter to Partners, Buffett Partnership LTD, July 1962).

Sure, you could wait for a clearer view of the future before making a purchase, but history has shown us that you pay a steep price for certainty. What Dean Witter said just two months before the stock market made a low in 1932 is still valid today: “Some people say they want to wait for a clearer view of the future. But when the future is again clear, the present bargains will have vanished. In fact, does anyone think that today’s prices will prevail once full confidence has been restored?”

In due time, the problems in the U.S. economy, interest rates, energy prices, China, etc. will be worked out. Eventually confidence will return and good businesses will soar to record-breaking profitability. Over the long term, no one has become rich selling America short.