• Robert Baharian

The Bear Market Has Finally Arrived

With a deafening roar, the US stock market ran headlong into bear territory, the S&P sinking 20% below a January peak and hitting its lowest mark since the previous January. This was on the back of US inflation data coming in higher than expected - well, that's my take anyway. The ASX has opened down almost 5% making up for a closed day yesterday. Technology shares have been leading the declines, with the Nasdaq 100 slumping about 4.5%.

Here's what the recent -21.8% decline looks like - yup, investors have finally capitulated.

So what does all of this mean for the market and for investors anyway? Let's dust off the history books and take a look at prior bear markets in terms of forward performance once the -20% threshold was reached (massive hat tip to Bespoke for this table).

The table below lists the 14 prior S&P 500 bear markets since WWII. No two bear markets are exactly alike, but on an average basis, it typically takes the S&P 500 244 days to reach the 20% threshold for a bear market, so at 161 days for the current period, the S&P 500 actually got to bear market territory quicker than average. Of the 14 prior bear markets, only four reached bear market territory faster than the current period (1946, 1987, 2009, and 2020), and of those, only two (1987 and 2020) were bear markets that started from all-time highs.

Once the S&P 500 reaches the 20% threshold, forward returns tend to be better than average, especially over the following year, and in more than half of the fourteen bear markets (8), the low was within two months of the 20% threshold being reached. Of the six bear markets that didn't reach the low within two months, three (1946, 1973, and 2000) dragged on for more than six months before the next rally of 20%+ commenced.

The bottom line is that history tells us that one year later the stock market was positive 78.60% of the time with an average return of 17.70% and a median return of 23.90%. There have only been three instances where the market's return was negative 12 months later - 1974, 2001, and 2008.

Going back even further, to 1926, market data show us US equity returns following sharp declines have, on average, been positive. A broad market index tracking data since 1926 in the US shows that stocks have tended to deliver positive returns over one-year, three-year, and five-year periods following steep declines. Cumulative returns show this trend to striking effect, as seen in the below chart (thanks to Dimensional).

On average, just one year after a market decline of 10%, stocks rebounded 12.5%, and a year after 20% and 30% declines, the cumulative returns topped 20%. Over three years, stocks bounced back more than 30% from declines of 10% and 20%, although—while still positive—returns were not as impressive after 30% declines. But five years after market declines of 10%, 20%, and 30%, the average cumulative returns all top 50%.

It probably feels a lot worse many investors - it's hard to see the forest for the trees. If we put the COVID crash aside, we've had a stellar run for many years (in fact including the COVID crash I would say). I think we've forgotten what a bear market feels like. And with the media digging its claws into this story, emotions are running high. One way emotions affect investing behavior is that we feel losses more intensely than we perceive gains. To see an S&P 500 index fund fall 20% can quickly overshadow the fact that the index has still returned, with dividends, almost 70% over the past five years. If you’ve been steadily investing in a diversified portfolio for years, you don’t need to be beating yourself up over any big mistakes right now. Your best response to a bear market may be to stick with your plan. If you are continuing to invest a bit of your salary each month, or even via your superannuation contributions, you are at least buying stocks more cheaply now. Having said all of that, if you're on the other end of your working life and you're not adding anymore to the pot, preservation becomes paramount.

That said, the unease you may be feeling can serve a purpose if it leads you to take a hard look at the makeup of your portfolio and the level of risk it carries. It’s a good time to ask if you really are comfortable with that risk and if it’s likely to serve you well across many market cycles, not just during the good times.

A look at the data makes a case for sticking with a plan. Handsome rebounds after steep declines can help put investors in position to capture the long-term benefits the markets offer.

My colleague Matt Rigby and I talk more about this in last week's The Wide Lens podcast.

You can also listen to the podcast on Spotify or wherever else you listen to your podcasts.