After another positive week, global stocks have pared most of their peak-to-trough declines during this correction.[i] Or, what we think is a correction—a sharp, sentiment-fuelled drop of -10% to -20%. Some financial commentators we follow have a different opinion and warn the past few days could be what people in our industry commonly call a sucker’s rally—a temporary positive burst that fools people into buying during a broader bear market, which is typically a much longer, deeper decline of -20% or worse with a fundamental cause. In all fairness, this is possible. Yet investing isn’t about possibilities—in our view, it is about probabilities. To avoid getting faked out, we think it is helpful to bear in mind some of what our research finds to be bear markets’ typical traits.
Corrections are usually short and steep from start to finish.[ii] Based on our historical research, they tend to start and end without warning, and they fall on feelings—sometimes tied to a big story, sometimes for no apparent reason. Sentiment usually appears to deteriorate throughout, generating a barrage of headlines warning this time is different and the decline will get worse. But then they end, usually as suddenly as they began, and a steep recovery typically follows.[iii] In our view, the best thing for someone seeking long-term growth to do during corrections is keep calm and hang on, lest they sell after a decline and miss the rebound—and miss returns that could compound over time.
Bear markets, by contrast, tend to last several months or more, usually rolling over gradually, with the worst declines coming late.[iv] In 2020, this wasn’t the case, as the bear market lasted just 17 trading days for the MSCI World Index—in our view, it was more like a correction than a bear market, despite the fact it technically was a bear market (the magnitude exceeded -20% and, in the lockdowns, we think it had a fundamental cause).[v] But that instance aside, our historical analysis shows bear markets are usually long grinds, and we think their slow start is what makes it possible to avoid part of their declines if you choose to do so and are correct in your analysis.
In general, and aside from 2020, we find bear markets typically behave similarly. Their monthly decline usually averages around -2%, give or take—sometimes a bit more, sometimes a bit less.[vi] Additionally, two-thirds of their decline by magnitude tends to come during the final one-third of their lifespan.[vii] Therefore, we think it is wise not to consider exiting stocks until you are at least three months from the most recent peak. Often, it may be preferable to wait several months past that. In our view, that gives you a good window to assess the decline’s pace as well as the fundamental backdrop. If it is a steep drop, then you are probably in a correction. If it is gentle and the financial news world is full of articles preaching buy the dips, we think there is a higher likelihood you are in a bear market.
As we write, global stocks are nearly four months from the most recent peak.[viii] If it is indeed the rebound from the correction, that should become apparent soon enough, in our view, considering global stocks are now just -2.9% below their 8 December high. If it is a bear market rally, eventually it and the surrounding declines will likely even out into that gradual monthly decline. Said differently, the rally will become part of that slow rolling top. Patience is difficult at times like this, but we think it is vital to seeing things clearly and reducing the risk of a portfolio error.
The watch-and-analyse window isn’t just for watching market movement—we think it is also for assessing fundamental conditions and sentiment to determine realistic probabilities about what likely lies ahead. As we write, based on our ongoing research and analysis, we think this is quite likely a correction, not a bear market. Maybe we are already in the recovery, or maybe this is a correction with a W-shaped trough instead of a V. But we don’t see the general conditions that our research finds usually bring a bear market.
When analysing the long arc of market history, we find bear markets usually begin one of two ways, which we call the wall and the wallop. The wall happens when stocks finish climbing the bull market’s (or a prolonged period of generally rising equity prices) proverbial wall of worry, and euphoric sentiment gets far ahead of reality. We don’t think the euphoria itself is bearish, but we have found that it blinds investors to approaching risks and deteriorating fundamentals, eventually driving stocks lower. The dot-com crash and bear market in 2000 – 2002 is a classic example, in our view.[ix] The wallop, as the name suggests, is a huge, shocking negative with the power and high probability of deleting several trillion pounds from global gross domestic product (GDP, a government-produced measure of economic output), which is what we think it takes to cause a broad decline in economic output, or recession. We think early 2020’s global lockdowns were a wallop, as was the 2007 – 2009 global financial crisis, which we think snowballed from a little-noticed US accounting rule.[x]
When stocks started declining in December, we didn’t observe investors to be euphoric—far from it. Based on our reading of financial headlines—which we have found both amplify and reflect popular sentiment, investors’ moods had deteriorated throughout 2021, resulting in a messy mix of scepticism and optimism when this year began. Inflation, geopolitics and pending US Federal Reserve and Bank of England interest rate hikes were all prompting financial commentators we follow to say that stocks would face choppier waters. As for a wallop, we have addressed all three in detail in recent months and, in short, we don’t think they qualify. We aren’t saying they are good, but at this juncture, we don’t think they have the size or surprise power that our research finds is usually necessary to send stocks far lower for far longer. Rather, we think all three are classic correction stories, much like China’s surprise currency policy shift in 2015 that many observers we follow called a devaluation and the eurozone’s debt crisis in 2011 and 2012.[xi]
The sucker’s rally warnings we are seeing now are also quite typical of a correction, in our experience—they are emblematic of the negative sentiment that usually reigns. Early bear markets, by contrast, tend not to feature so much gloom. The early declines seem so gentle that few financial commentators or analysts extrapolate them into much deeper trouble. They more often dismiss the declines, prompting the aforementioned chorus of buy the dips chatter. If bull markets climb a wall of worry, then one could say bear markets roll down a slope of hope.
In our view, one of the most frustrating things about stocks is that inflection points are clear only in hindsight. But we think investing has always been an endeavour of probabilities, not certainty—and not possibilities. In our view, whilst we can’t (ever) be certain, we think the overwhelming probability today is that this year’s early volatility is (perhaps was) a correction, with still-brighter days likely to come sooner than many think.
[i] Source: FactSet, as of 29/3/2022. Statement based on MSCI World Index return with net dividends in GBP, 8/12/2021 – 28/3/2022.
[ii] Ibid. Statement based on MSCI World Index with net dividends in GBP.
[v] Source, FactSet, as of 29/3/2022. Day count is global trading days based on the MSCI World Index return with net dividends in GBP, 20/2/2020 – 16/3/2020.
[vi] Ibid. Statement based on S&P 500 price returns in USD, 31/12/1925 – 31/12/2021. US returns in US dollars used in lieu of global returns in Sterling due to the S&P 500’s long dataset of daily return data. Currency fluctuations between the dollar and pound may result in higher or lower investment returns.
[viii] Source: FactSet, as of 29/3/2022. Statement based on MSCI World Index return with net dividends in GBP, 8/12/2021 – 29/3/2022.
[ix] Ibid. Statement based on MSCI World Index return with net dividends in GBP, 18/9/2000 – 9/10/2002.
[x] Ibid. Statement based on MSCI World Index return with net dividends in GBP, 20/2/2020 – 16/3/2020 and 12/10/2007 – 6/3/2009.
[xi] Ibid. Statement based on MSCI World Index return with net dividends in GBP, 10/4/2015 – 25/8/2015, 7/7/2011 – 19/8/2011 and 15/3/2012 – 18/5/2012.
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