Caution: Don't feed the bears!
The history of bear markets offers insight into the current one.
In June 2022, we officially hit bear market territory for the S&P500, the widely used barometer of US stock market prices. As of the writing of this article, the market is down ~22% on the year. We all want to know how bad this will be. Is there anything we can learn from previous bear markets that might help?
A bear market is defined as a 20% drop in stocks. It’s one of the worst statistics in investing. 20% is an arbitrary standard that emerged in the 70s and 80s. In the ~75 years after 1945 there have been 13 perfect 20% or greater bear markets. Improbably, there have also been five years in which there was an ‘almost-bear’ market between 19.4% and 19.9% losses. They rarely get counted in statistics.
Bear markets are also not based on actual investor returns and losses. Those returns include dividends, which are usually about 2%-3% of a long-term return. If you like to include the Great Depression in your dataset, you’ll have to decide if the eight bear markets it contains were separate events or one giant bear market.
And no one counts inflation, but it has to be counted! For instance, there was a 12-year period from 1973-1985 where no portfolio of stocks and bonds had any inflation adjusted gains. It’s a squishy definition when you pick it apart but we need something, right?
This marks our 26th official bear market in the USA since 1929, and the 18th since the end of WWII. The average drop has been a loss of 30% and they have lasted, on average, about a year in length. The good news, if you can call it that, is it typically takes much longer to reach 20% losses than to reach the bottom.
Why haven’t I mentioned the recession? I did here. And since I only have you for 750 words, I want to focus on the bear market. Recessions tend to lag the bear market by a quarter or two so maybe we see it in 2023? I don’t know. If you are a long-term investor, hang in there. This is very likely just a bump in the road.
A 2020 analysis by Goldman Sachs looked at all U.S. market drops over 20% and found they fell into three broad categories based on their triggers and features: cyclical, event and structural. I updated and modified the Goldman report to include the current bear market, add the almost-bears and add the cause or name of the bear market so you can see some historical context. The data is below.
Event: These are one-off shocks, like Covid-19, that cause great distress but don't always lead to a domestic recession. Other examples include an oil price shock or armed conflict. Before Covid, the last example of this was Black Monday in 1987, Cold War events in the 60s, and others. These are not that common and mercifully short.
Cyclical: You are familiar with the classic economic business cycle. Growth increases, inflation rises, interest rates increase to tackle inflation, and recession follows along with falls in profits. These were extremely common before 1932 when the Federal Reserve was created. This is likely the type of bear market of 2022 and they are common and medium in length
Structural: These are triggered by economic structural imbalances and financial bubbles, such as the Great Depression and 2008 Great Recession. There's often a price shock, such as deflation, that follows. Both the 2002 technology crisis and 2007 financial crisis were structural. The Great Depression contains 8 of the 11 structural bear markets and might reasonably be considered one long bear market. These are less frequent but very harmful because we lose faith in the system itself. Fear at its deepest.
What can we learn from this?
It’s no reason to go out and buy stocks today, and this is most certainly not investment advice. But a cyclical bear market is a common type of bear market that has been generally shallower than the more fearsome structural type. I see some, but not as many, structural issues in the financial markets right now compared to 2002 and 2008, so I’m hopeful that this one will be less painful.
