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Most investors have a misguided view of what bear markets are and few know how to identify them. But when the market experiences volatility, being able to discern a correction from a bear market can be a huge help. With thorough analysis and practice, we believe a fundamental market crash can be identified and potentially even side-stepped. This article describes bear markets, how Fisher investments defines them and some general characteristics.
We define a bear market as a fundamentally-driven stock downturn of about 20% or more over an extended period of time. Given this definition, the S&P 500 saw 11 bear markets between 1946 and 2018, lasting on average, 16 months.[i]
Exhibit 1: S&P 500 Bear Markets 1929 – 2009
Source: FactSet, Global Financial Data, as of 12/24/2018. S&P 500 Price Index Level from 05/29/1946 - 12/21/2015. Returns are presented exclusive of dividends. For “Duration,” a month equals 30.5 days.
Bear markets are commonly remembered for the widespread fear they cause as investors watch their account values drop. This fear sometimes leads investors to panic and abandon their investment strategy, which may ultimately be costly if they sell their investments at a loss and potentially miss out on the rebound.
Bear markets often begin with an inconspicuous slowing of market momentum at a time when investors are feeling overly confident and keep bidding stocks up despite deteriorating earnings. As market fundamentals show weakness or warning signs, euphoric investors ignore them and instead look for reasons their stocks should continue their rise.
We have four basic guidelines to identify bear markets. It’s important to keep in mind that no two bear markets are the same, therefore no one rule is perfect for identifying every bear market.
Four Bear Market Rules
Don’t confuse economic recessions and bear markets. An economic recession is commonly defined as two consecutive quarters of negative gross domestic product (GDP) growth. While the two may coincide, bear markets can occur without a corresponding recession and vice versa.
Bear Market Indicators
Although no single indicator can accurately identify every, we believe a combination of leading indicators coupled with research and analysis can help you identify a bear market in its early stages and potentially avoid some of the ensuing decline.
We believe fundamentals play a key role in determining the current state of the market. A few examples of negative fundamentals include:
Just as important as fundamentals, history has shown that investor euphoria can precede a bear market. Indicators of euphoria may include:
When euphoric investors start searching for reasons that stocks will keep rising and begin to dismiss negative fundamentals, a bear market could be in the horizon.
Every bull market climbs the proverbial “Wall of Worry”—short-term worries that can boost investor fear and volatility during a broader bull market. These worries sometimes even lead to corrections—sharp sentiment-based downturns of about -10% to -20%. But these short corrections typically lack the size and scale of a true bear market, and since they are often based on fear, trying to trade around corrections can be a futile exercise.
Sometimes a bull market runs into an unexpected negative big enough to knock several trillion dollars off global GDP. Think of it as a big, bad, unexpected negative that “wallops” an otherwise strong economy and bull market. Often investors misunderstand an event’s impact and how it fits into the bigger picture. Overestimating the potential impact of any event could cause investors to falsely spot wallops or mistake bull-market corrections for bear markets.
It can be difficult to determine what will lead to the next bear market or correction. Timing corrections is nearly impossible, as they start with a bang and end just as quickly. And going defensive for a correction could mean reducing equity exposure, which can also set you back. We believe most investors are often better off staying disciplined and riding through corrections and other bull market volatility.
Finally, we debunk one of the most prevalent yet dangerous investing myths: One big bear market and you’re done! Chances are, even if you weathered every bear market without making one defensive move, your equity portfolio would still have generated a cumulative profit over the longer term (think 20 to 30 years). We’ve observed that bull markets are often longer and stronger than their preceding bear markets. Keep in mind that every bear market is followed by a bull market. If you wait too long to re-enter the stock market after a crash you may miss out on the next bull market’s initial bounce.
Worried about what you will do in the next bear market? Fisher Investments may be able to help you manage your portfolio through bear markets and other stages of the market cycle. Contact us directly to set an appointment.
[i] Source: FactSet, Global Financial Data, as of 12/14/2018. S&P 500 Price Index Level from 05/29/1946 - 12/21/2015. Returns are presented exclusive of dividends. For “Duration,” a month equals 30.5 days.