The carnage this year has been relentless, and the S&P 500 is flirting with bear market territory. What can history tell us about the severity of bear markets, and if the index continues to fall, what should investors do next?
While some investors may assume that the term “bear market” got its name from how bears attack their prey, it actually originates from bearskin traders in early America. They would often sell skins before they received or even paid for them. Because the traders hoped to buy the fur from trappers at a lower price than where they'd sold it, "bears" became synonymous with a declining market.
Today, the definition of a “bear market” has evolved to a drop of 20% or more from recent highs in an index. The S&P 500 is approaching “bear market” territory, and the Nasdaq and Russell 2000 indices are already there. Investors are justifiably anxious to know what could happen next. Rather than try to estimate the odds of dipping into a bear market from here, let’s instead try to get an idea of what one could look like by using history as a guide.
1. Their impact has been minimal.
There have been 26 bear markets in the S&P 500 since 1928. However, there have also been 27 bull markets. Take the good with the bad, and the index’s total return has still averaged more than 10% annually1. That means $100 invested in 1928 would be worth over $828,000 today. This investment would have also beat inflation for an inflation-adjusted return of 6.8%2.
More specifically, bear markets have occurred every 3.6 years on average since 1928. They have also become less frequent since World War II. Between 1928 and 1945 there were 12 bear markets, or one about every 1.4 years. Since 1945, there have been 14, or one about every 5.4 years3.
2. Recessions aren’t guaranteed.
There have been 15 bear markets since 1950, but only 8 of these predated a recession3. Furthermore, half of the S&P 500 index’s strongest days in the last 20 years occurred during a bear market. Another 34% of the market’s best days took place in the first two months of a bull market (before it was clear a bull market had begun)4. Shelby Davis, one of the most respected investors of all time, famously said the following for this reason:
“You make most of your money in a bear market; you just don’t realize it at the time.”
3. They haven’t stuck around for long.
The chart below shows the daily historical performance of the S&P 500 through both bull and bear markets going back to 1942. The average bear market period lasted 11.3 months with an average cumulative loss of -32.1%. But the average bull market period lasted 4.4 years with an average cumulative total return of 154.9%5. Furthermore, over the last 92 years, bear markets have comprised only about 20.6 of those years. The other 78% of the time, stocks were climbing6.
Simply put, bear markets are a feature of the stock market, not a bug. They don’t happen often, but when they do, they tend to be short lived and only occasionally signal economic calamity.
The Bottom Line
Bear markets offer attractive returns because investors tend to overreact during selloffs. But discount shopping at the New York Stock Exchange isn’t quite the same as at Macy’s. Even the most frugal shopper sifting through sale racks won’t endure a fraction of the stress involved in buying stocks when they appear to be in freefall.
Another challenge is having the cash to put to work. If it’s there, then it begs the question of why that cash wasn’t already invested. Has it been sitting there just waiting for the bear market to arrive? If so, how much return was forfeited while waiting? Because as much advice as there is about being greedy when others are fearful, there’s just as much out there about how market timing doesn’t work.
We prefer to remain fully invested for this reason, but that doesn’t mean we are going to let opportunity pass us by either. A cornerstone to our investment strategy is attempting to profit from the fear and panic of others, so we are already hard at work looking for stocks that are on sale. When we find them, we plan to adjust our allocations accordingly.
The bottom line is that bear markets have historically been some of the best times to invest and/or increase an allocation to a diversified portfolio of stocks. If the broader market dips into a bear market down the road, we see little reason to think that this time would be any different.
Brian Malizia, President
Mike Sorrentino, CFA
1. Bloomberg, Darwin Asset Management analysis
4. Ned Davis Research, 12/21. Time period referenced is 12/16/01–12/15/21.
This newsletter/commentary should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no guarantee that any investment plan or strategy will be successful.