Singing the Bear Market Blues

By on June 22, 2022

A lot of ink has been spilled in recent days about bear markets. The widely accepted definition of a bear market is when a major index declines 20% from a recent high, with the end of the bear market coming when the same index hits a fresh high. This past Monday, the S&P 500 Index crossed the minus-20% threshold and thus began the fourth bear market of this century. (The other three began in March 2001, July 2008, and March 2020.) This is the eleventh bear market since the inception of the S&P 500 Index in 1957. (Source:  yCharts)

Bear markets are understandably stressful and can be emotionally draining. Newer investors, who have only seen markets rise, may be disarmed by the rapid shift in the market environment. Recent retirees, or those contemplating retirement in the next few years, are acutely aware of their reliance on portfolio assets which are now materially diminished. This stress is reinforced by the sometimes hysterical, constant drumbeat of pessimistic media reports.

We’d like to take this opportunity to make several observations about past bear markets. Some might seem absurdly obvious, but we think are worth restating. Others are a bit more nuanced. Regardless, we hope you find this recap useful in putting today’s markets in perspective.

All bear markets eventually end, sowing the seeds of the next bull market. Bear markets remind investors that attractive long-term returns on stocks do not come without risk and extended periods of pain. These periods wash away the speculative excess that tends to build up in certain parts of the market:  the “Nifty Fifty” stocks of the early 1970s, dot-com stocks in 1999-2000, banks and other financial firms in 2008, and unprofitable “unicorn” tech stocks and crypto-related companies today. The pain inexorably spreads more widely, taking most if not all sectors of the stock market along with it. Often, but not always, a bear market will be accompanied by an economic recession. But the gloomy days don’t last forever. As stock prices drop, value-oriented investors begin stepping in to buy “cheap” assets, a stock market bottom is established, and the market begins its climb to new highs.

Bear markets vary significantly in their duration and magnitude, but markets are usually higher as soon as one year after entering bear market territory. On average, once the S&P 500 has fallen 20% from a recent peak, it has taken 31 months for the market to reach a new high. But there is wide variation around this average. At one extreme, consider the bear market of 2020. As the impact of COVID-19 became clearer, the stock market sold off sharply; after peaking on February 19th, the S&P 500 plummeted 34% in less than five weeks, bottoming on March 23rd. It reached a new high on August 18th, just six months after the prior peak. It didn’t take long for investors who bailed out during the wicked selloff of March 2020 to regret their decision. At the other end of the spectrum is the grinding bear market that began in November 1973 with the Arab oil embargo. In this case, as “stagflation” (low growth combined with high inflation) took hold in the economy, the S&P 500 did not reach a fresh high until July 1980, a full 7½ years after the prior peak. (Source:  yCharts)

One might wonder, now that we’re in a bear market, how likely is it that returns will be positive going forward? Again, history provides some guidance and, perhaps, comfort. In seven out of 10 bear markets (70%), the S&P 500 has been higher one year after entering a bear market. At the three- and five-year marks, it has been higher in seven out of nine (78%) bear markets. In only one bear market (the aforementioned 1973-1980 grinder) was the S&P 500 lower 10 years after the inception of the bear market. (Source:  yCharts)

Selling stocks (or other risk assets), with the intention of “sitting out” a bear market—an undeniably seductive plan—is rarely a productive strategy. We understand the temptation of reducing one’s risk exposure in this type of environment. Often this thought process is accompanied by statements like: “I’ll get back in once there’s more clarity” or “I’m going to wait until there’s less volatility.” But it is incredibly rare for investors to successfully execute this approach. Think back to the market bottoms in March 2009 (the depths of the Global Financial Crisis with the unemployment rate at 8.6% [Source:  yCharts]), or March 2020 (the early days of the COVID-19 pandemic, when the economy was going into shutdown/stay-at-home mode). If you had been smart, or lucky, enough to sell your stocks weeks or months earlier, would you really have felt optimistic enough at those junctures to take the plunge and buy back in? Keep in mind that media outlets and many financial professionals, in both cases, were confidently forecasting a prolonged recession or even a depression. Additionally, for taxable investors, the cost of selling and then buying back in may generate a sizable capital gains tax bill.

Broad diversification has helped investors weather past bear markets. The “dot-com” crash of 2000 – 2002 followed by the Great Recession from 2007 – 2009 are particularly instructive on this point. While the poor returns of the S&P 500 are often considered the defining investment characteristic of what became known as “The Lost Decade” for investors, this storyline is not entirely accurate. Consider the following annualized returns for the full decade (Jan. 2000 through Dec. 2009):

Int.-Term Bonds (Bloomberg U.S. Govt./Credit Bond Intermediate)         5.92%

Municipal Bonds (Bloomberg Municipal Bond)                                     5.75%

U.S. Large Cap Stocks (S&P 500)                                                     -0.95%

U.S. Small Cap Stocks (Russell 2000)                                                 3.51%

International Stocks (MSCI ACWI ex USA net div.)                              2.71%

Real Estate Securities (Dow Jones U.S. Select REIT)                            10.67%

(Source:  Dimensional Returns Web)

A disciplined investor, diversified across these asset classes during the 2000s, should have been able to eke out an annual portfolio return of 3.5%-4.0%. Certainly not spectacular, but much better than the S&P 500’s negative return and above the annual inflation rate of 2.52% (Source:  Dimensional Returns Web) during that decade.

A major factor for successful investing is the ability to live with uncertainty. We don’t know how long this bear market will last. If coming months bring news of easing inflation pressures and hopes that the Federal Reserve will be able to engineer a “soft landing” (raising interest rates without sending the economy into recession), we may end up experiencing a relatively short bear market. But if inflation remains persistent and the Fed is forced to aggressively raise rates further (e.g., a continuation of the news trend we’ve seen in the past couple weeks), we may have to endure a longer, more difficult economic environment before green shoots spout once again.

Regardless of how long it takes, we will be here to guide you through the trials, tribulations, and triumphs on your financial journey. Please do not hesitate to reach out to your D&Y advisor with any questions you may have about your finances and the current market environment.



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