Mid-Year 2018: Bear Market Fears

The U.S. stock market is two months shy of the record for longest running U.S. bull market. Since March 2009, U.S. stocks have climbed over 300%.

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Considering that backdrop, we’re surprised that the dominant sentiment in the media and among clients is consternation. Every day, an article sleuths for a leading indicator of the next bear market – e.g. the U.S. Treasury yield curve, tariffs, tech stocks, etc. Similarly, a number of clients have drawn straight lines from the news cycle to bad returns on the horizon.  

To adapt a famous quote, investors have predicted twelve of the last two bear markets. In the current bull market, there have been multiple bear scares: European debt, Brexit, China’s stock market crash, to name a few. Anyone who let fear cause them to flee the market missed one of the greatest stock runs of their lifetime.

It’s natural to wonder about the next bear market. The risk – a bigger risk even than portfolio declines – is that wonder turns to fear and fear leads to action.

It is important to be mindful but not fearful. Here are some thoughts and predictions about bear markets to add some context to concerns.

The Next Bear Market – When?

That the bull market is nearing record length does not mean the next bear market is around the corner. The next bear could start in a month or in five years. The record duration says more about the definition of a bear market and the nature of the last bear than it does about when the next bear will strike.

Bull markets officially end when the market declines 20% from its peak. Were it not for the arbitrary nature of that -20% threshold, the record books would look very different. In 2011, the S&P 500 declined 19%, but never touched -20%. In the 1990s (the current longest bull), there were two -19% drawdowns.  

Moreover, the 2007-09 bear market was the worst since the Great Depression. It took years for the economy to find its footing and for crisis era systems to be unwound. As a result, the early years of this bull market were spent recouping lost ground.

The Next Bear Market – How Much?

Of the eight post-World War II bear markets, this century has seen two of the largest crashes: 2000-02 (-49%) and 2007-09 (-57%). Only one other crash has been greater than 40%, in 1973. The average post-WWII bear market dropped 30% peak to trough.

The severity of the last two crashes has investors expecting extreme levels of portfolio pain. While an average bear would be very unpleasant, there is a chasm between -30% and -57%. Investors should not presume that the next bear will be as severe as the Great Recession.

The Next Bear Market – Why?

While a bear market could start at any moment, today’s environment is missing one important hallmark of previous bears.

Recent meltdowns have sowed the seeds of their destruction through over exuberance (tech stocks in 1999 or housing prices in 2007).  During the bull market most similar in size and length to today – the 1990s – we recall investors’ unfettered optimism even in the days leading up to the downturn.

While identifying when sentiment overshoots reality is very difficult, there are no parts of the market or economy that seem exuberant. The Great Recession produced skeptical investors. This cynicism may be helping to suppress bubbles that could have inflated given a more enthusiastic audience.

The Next Bear Market – Predictions

We do not make market or economic forecasts. Still, we cosign financial blogger Ben Carlson’s predictions about the next bear market:

·        It will feel like the selling is never going to end.

·        You’ll be kicking yourself for not holding more cash or bonds.

·        Investors will make short-term decisions with long-term capital at stake.

·        Everyone will start paying attention to the markets again.

·        You’ll trick yourself into believing you should have seen it coming.

·        You’ll be convinced that a 20% loss will turn into a 30% loss, a 30% loss will turn into a 40% loss and a 40% loss will turn into the Great Depression.