How Dangerous Is The Bear Market?

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On a recent trip to Banff, I had the chance to see many black bears from afar. The guide notes that black bears are generally not dangerous if you don’t disturb them. Grizzlies, on the other hand, are much more dangerous—even if you’re smart about how you interact with them. The experience brought to mind the situation we find ourselves in today: the bear market. But is this a black bear market, in which case we can go ahead and assume that it will eventually leave us alone? Or is it like a grizzly bear market and will affect us no matter how smart we try to be? To find out, let’s take a look at history and see what clues it can provide.

bears of the past

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One way to help determine this is to look at past bear markets and what was happening at the time. An analysis by JPMorgan lists 10 bear markets from 1929 to 2010 and notes whether there was a recession, commodity prices rose, or the Fed raised interest rates, as well as markets. Was at peak evaluation or not. They all had at least one of these risk factors.

However, when you look at the impact of risk factors, you can draw out some interesting data. In 1962 and 1987, the only risk factor was assessment—and both of those accidents were fast but very few. Interestingly, those were also the only two bear markets that happened in the absence of a recession. Bear markets that are based solely on valuations, not economic factors, are less frequent.

Which doesn’t give us much comfort today. Given those factors, we have rising commodity prices in energy. We have the Fed aggressively raising interest rates. And we have — and still to some degree — have a lot of valuations on a historical basis. Given those factors together, the current bear market is not too surprising. We are in it and may be for a while.

recession risk

The remaining risk factor question is whether we even get bearish. Here, the evidence is mixed. While sentiment is dire and risks are rising, the data so far—job growth, confidence and yield curves—still remains out of risk zones. We still have some momentum for us, which should keep us growing through the rest of the year overall. It certainly won’t pull us out of a bear market, but it should help keep it less damaging and less likely to be in black bear, not brown bear territory.

This is good news because when you look at data from past bear markets, they suggest we still have a way out before we get out. The average length of the 10 JPMorgan reviewed was 25 months, with an average decline of 45 percent. But if you remove the worst of them, the real grizzly bears of the 1920s and 1930s, and go back to “only” 1962, you get much less average length and decline. Given the decline we have already seen, this suggests that future damage may be limited. If we don’t get a recession by the end of the year, our situation will be even better.

what is next?

When you put all of these together, we can reasonably conclude several things. Firstly, this bear market will not reverse tomorrow. We will deal with this for some time. The risk factors are real and will not go away anytime soon. As an investor, we need to be prepared for this.

Second, though, we have a deadline and things to look at. Given the risk factors, oil prices will be important, as will the Fed’s interest rate policy. They will roll over at about the same time, as energy is a major driver of inflation. Similarly, recession risks will roll in as energy prices and rates top. Although there are real risks out there, we know what to look for on the economic side – and there is reason to believe that we are passing through the worst of it all.

On the market side, the good news is that valuations have already returned to typical levels of the last 10 years and have begun to approach those prior to the financial crisis. This limits the potential duration as well as potential future losses.

Another analysis that suggests the same thing is to look at future returns since the bear market began. Looking at the most recent 10 bears, the markets were up 80 percent after 3 months. While there was some subsequent pullback, they were still up 60 percent of the time after 6 months and 70 percent of the time after 12 months. Most of the losses happen at the start of a bear market, so we can pass the worst of it even if it continues.

Could it be worse?

It certainly could. But with pre-existing risk factors, and this is largely accounted for, this is not and may not happen. One major risk factor is getting closer to a solution, while we can see how others will solve as well. Will it end soon? Maybe not. But most losses are likely, and history shows that we may see a return to the market sooner rather than later. Is it a brown bear or a black bear? So far, it looks like a black bear market. As we have seen, black bears have teeth and claws, but they are also more likely to back down than attack.

scary but normal

The last point we can take from past bear markets is simply this: they end. When the economy rebounds (which it does), when investors gain confidence (which they do), and when we move from fear to optimism (which we will), the market will recover and go up. Will grow. This has happened after every single bear market so far, and it will happen after this. As investors, in fact, this type of volatility allows for substantial returns over time. On one hand, it’s a scary time. But on the other hand, it is both normal and necessary.

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