“Bull markets really only end two ways: The Wall or The Wallop. The Wall is: They climb the 'Wall of Worry' until there’s no more worry. Or The Wallop is: They get hit by a big, bad thing that nobody ever talked about before, which is at least a couple of trillion dollars in magnitude ... You look for those two, and otherwise, all the little stuff, you want to not pay too much attention to.”
–Ken Fisher, Fox Business Network Interview on 18/12/2014
Bear markets—by definition, fundamentally driven market drops of approximately 20% or more over an extended period—are a common fear for investors. It’s no surprise many investors spend time trying to identify anything likely to cause a bear market, as they worry failing to recognise the next downturn on the horizon will severely hurt their chances of meeting their long-term financial goals. Unfortunately, whilst it’s easy to pinpoint a bear market in hindsight, identifying a bear market whilst it’s unfolding is much more difficult. The key is having the perspective to watch for and identify the right components, and then have the discipline to prevent your emotions from causing you to make poor decisions.
What are some common causes of bear markets that suggest one might be forming? Fisher Investments believes there are just two ways bear markets start:
1.) The Wall: A bull market—a sustained period, generally years, of rising equity prices—climbs the “Wall of Worry,” then runs out of steam amid widespread investor euphoria.
2.) The Wallop: A negative surprise with the power to knock several trillion dollars off global Gross Domestic Product (GDP) hits an ongoing bull market.
Most often bull markets end by running out of steam, best described by legendary investor Sir John Templeton: “Bull markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria.”
It is often said bull markets climb a “Wall of Worry,” with many widely held fears constituting the “bricks.” Examples from the 2009 – 2020 bull market include: the Russian-Ukrainian conflict; Ebola; the Brexit vote; North Korean missile tests and many more. Exhibit 3 shows the “Wall of Worry” this bull market climbed. Each of these events worried investors, but did not have the size or surprise power to cause a bear market, and fundamentals at the time supported future growth—allowing the bull market to continue climbing.
Exhibit 1: The “Wall of Worry”
Source: FactSet, as of 7/6/2017. MSCI World Total Return Index Level (Net) from 12/31/2008 – 6/30/2017. Presented in US dollars. Currency fluctuations between the US dollar and pound may result in higher or lower investment returns.
Typically, though, as a bull market matures, more and more fears are dispelled and newly confident investors tend to buy into stocks. When all worries wane, the absence of fear suggests you are at the Wall’s euphoric top. At that stage of a bull market, investors think the stock market will rise upward forever—“It’s different this time.” Once investor sentiment reaches euphoria, reality can’t keep up with sky-high expectations and the bull market runs out of steam. This is the traditional way bear markets begin and Fisher Investments believes it generally follows this formula:
A bear market usually starts when corporate and economic fundamentals are overall trending downward, but investors are caught up in euphoria—they either dismiss weakness or don’t notice it at all. They remain bullish and continue investing more money into the stock market, looking for profits.
Sometimes a bull hits an unexpected, immovable object big enough to knock a few percentage points off global GDP—and this alone can be enough to cause a bear market. What does Fisher Investments mean by “immovable object”? It’s a big, bad, unexpected negative that “wallops” an otherwise strong economy and bull market. In this case, the unexpected negative is itself enough to derail the bull market:
Be careful, though, or else you’ll think you see Wallops around every corner and find it difficult to be bullish. In Fisher investments’ view, a potential Wallop must be big enough to knock a few trillion dollars off global GDP in order to qualify.
Let’s take the Global Financial Crisis of 2008 – 2009 as an example: That was a bear market caused, in Fisher Investments’ view, by an ongoing bull market hitting an immovable object that brought it to a premature end—namely, the US FAS 157* (mark-to-market accounting) combined with the US government’s chaotic response to the financial crisis. This combination turned what otherwise might have been a correction into a full-blown bear market. Global GDP fell by more than $3 trillion—over 5%.** In Fisher Investments’ view, FAS 157 and the government’s unpredictable actions Walloped the bull market.
The Wallop may coincide with the Wall—if a bull market that happens to be at the top of the “Wall of Worry” is Walloped:
*FAS 157 was an accounting rule dictating that even illiquid assets would be valued at the price at which they would be sold if they had to be sold immediately (also known as “mark-to- market” accounting). This price was often the last sale price of a comparable asset. When it came to non-public, rarely traded assets with no regular market pricing, the last sale price could be outdated or far removed from current values. Or, the asset could be intended to be held to maturity, in which case the current market price was irrelevant to its ultimate value as the current market price would not be realised unless the holder was forced to sell immediately. In the early months of the bear market, FAS 157 made financial institutions susceptible if the markets for their illiquid, non-publicly traded holdings experienced negative volatility.
**Source: FactSet, as of 10/12/2015. World GDP from 12/31/2008 – 12/31/2009 per World Bank data.
Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.