This Bear's Evolving Fears Parallel the Past

In the past few days, investors’ fear has mushroomed beyond COVID-19 containment efforts and their immediate fallout. As the dollar has strengthened—normal during a recession and bear market—so have fears of companies and governments abroad struggling to service dollar-denominated debt. The gyrating corporate bond market is fanning fears of an allegedly long-overdue reckoning in junk bonds. Rising sovereign yields brought Italian debt crisis fears back. So are worries of imminent collapse in a smattering of industries, including travel, autos and retail—a lot of which carry a tinge of “this time is different.” We won’t try debunking any of these for now—there will be a time for that later. Rather, we will simply note that spiraling, spreading fear—a hunt for “the next shoe to drop”—is normal as a bear market worsens and not a roadblock to its eventual end.

You can see this in a number of past bear markets. Last time around, fears morphed from banks and subprime mortgages to the auto industry, the north-south economic divide in the eurozone, hyperinflation due to aggressive monetary policy and a years-long recession on par with the early 1930s. TARP and fiscal stimulus efforts drove fears of spiraling debt and deficits. The surging dollar in late 2008 had many fearing a reckoning; when this reversed and weakened later, many feared a dollar crisis. Toward the bear’s end, people were even speculating that stocks could go to zero. Morphing panic is part of a bear market’s evolution.

The 2000 – 2002 bear market had a similar fear morph as the dot-com implosion rippled throughout the broader economy. The tragedy of 9/11, which occurred a year and a half into the bear and six months into the recession, added airline industry woes and related pension dread. It also added fears over prolonged armed conflict in the Middle East. Enron and other accounting scandals drove worries that no company’s books were reliable.

Ten years prior, 1990’s bear market occurred in the shadow of the Savings & Loan Crisis and featured a shallow recession. But investors also grappled with the prospect of German reunification—an extraordinary marker of peace, but one with potentially severe economic consequences for continental Europe if not executed correctly. Iraq’s invasion of Kuwait simmered in the background, rekindling fears of Middle East conflict.

You could perform a similar exercise for all other past bear markets. In doing so, you will also see that while some of the accompanying fears are valid and some are false, it wasn’t necessary for all these issues to fade in order for a new bull market to begin. Rather, the fear spiral usually continued well into the recovery. In 2009 and 2010, investors reckoned with double-digit unemployment, sovereign debt troubles in Dubai and Southern Europe, American healthcare and financial reform and sky-high deficits across the Western world. In 2003, the US-led Iraq war and SARS (also a coronavirus, in an eerie parallel) roiled sentiment as stocks climbed. In 1991, it was the Soviet Union’s collapse, which threatened to ripple economically through Europe. In 1983, the US invasion of Grenada and a severe municipal bond default fanned fears. In 1975, it was New York City’s bankruptcy.

Simply put, the existence of fears—warranted or not—isn’t reason to be bullish or bearish. What matters most is the degree to which those fears are priced into stocks and whether reality is likely to be marginally better or worse. The more fear gets baked in, the higher the likelihood of a better-than-expected outcome becomes. Not a positive outcome, mind you—incrementally less bad than feared can be enough to help the tide turn.

So in our view, the appearance of new worries, in and of itself, isn’t a reason to become more anxious than you might otherwise be. It doesn’t mean things are uniquely worse now than in past bear markets. Rather, it just makes this bear, though unique in its suddenness, similar to its historical predecessors in how it is influencing investor sentiment.