A History of Bear Markets

Despite the U.S. stock market's robust rally at the start of 2019, its unnerving fourth quarter sell-off warned many investors that the 10-year-old bull market, the longest ever, could quickly turn into a bear market. The last sustained market plunge happened so long ago that many older investors may have largely forgotten what one is like, while younger investors have no experience at all with a bear market's pain.

This story examines what investors might expect based on history. A bear market occurs when stocks, on average, fall at least 20% off their high.

Several leading stock market indexes around the globe endured bear market declines in 2018. In the U.S. in December, the small cap Russell 2000 Index (RUT) bottomed out 27.2% below its prior high. The widely-followed U.S. large cap barometer, the S&P 500 Index (SPX), just missed entering bear market territory, halting its decline 19.8% below its high.

Both U.S. indexes subsequently rebounded, with the Russell and the S&P now down by 14.8% and 9.1%, respectively, from their highs as of the close on Jan. 25, 2019. The Russell thus remains in a correction, which is a drop of 10% or more.

Note that the preceding figures are based on closing prices. A less common method is to look at intraday prices. On this basis, the S&P endured a bear market decline of 20.2%. In any case, the market's early 2019 rebound has done little to lift investors' confidence in the market longterm.

What will spark the next bear market? An economic recession, or the anticipation of one by investors, is a classic trigger, but not always. Another trigger has been a sharp slowdown in corporate profit growth, as we are seeing now. Also, bear markets have come in all shapes and sizes, showing significant variation in depth and duration.

Look at these numbers. Since 1926, there have been eight bear markets, ranging in length from six months to 2.8 years, and in severity from an 83.4% drop in the S&P 500 to a decline of 21.8%, according to analysis by First Trust Advisors based on data from Morningstar Inc. The correlation between these bear markets and recessions is imperfect.

This chart from Invesco traces the history of bull and bear markets and the performance of the S&P 500 during those periods.

Today, stock market pundits are widely divided about the nature of the next bear. For example, Stephen Suttmeier, the chief equity technical strategist at Bank of America Merrill Lynch, has said he sees a "garden-variety bear market" that will last only six months, and not go much beyond a 20% dip, per CNBC. At the other end of the spectrum, hedge fund manager and market analyst John Hussman has been calling for a cataclysmic 60% rout.

Three of those eight bear markets were not accompanied by economic recessions, according to FirstTrust. These included brief six month pullbacks in the S&P 500 of 21.8% in the late 1940s and 22.3% in the early 1960s. The stock market crash of 1987 is the most recent example, a 29.6% drop lasting only three months, per First Trust. Concerns about excessive equity valuations, with selling pressures exacerbated by computerized program trading, are widely recognized as the trigger for that brief bear market.

In three other bear markets, the stock market decline began before a recession officially got underway. The dotcom crash of 2000-2002 also was spurred by a loss of investor confidence in stock valuations that had reached new historic highs. The S&P 500 tumbled by 44.7% over the course of 2.1 years, punctuated by a brief recession in the middle, per First Trust. Stock market declines of 29.3% in the late 1960s and 42.6% in the early 1970s, lasting 1.6 years and 1.8 years, respectively, also began ahead of recessions, and ended shortly before those economic contractions bottomed out.

The two worst bear markets of this era were roughly in sync with recessions. The Stock Market Crash of 1929 was the central event in a grinding bear market that lasted 2.8 years and sliced 83.4% off the value of the S&P 500. Rampant speculation had created a valuation bubble, and the onset of the Great Depression, itself caused partly by the Smoot-Hawley Tariff Act and partly by the Federal Reserve's decision to rein in speculation with a restrictive monetary policy, only worsened the stock market sell-off.

The bear market of 2007-2009 lasted 1.3 years and sent the S&P 500 down by 50.9%. The U.S. economy had slipped into a recession in 2007, accompanied by a growing crisis in subprime mortgages, with increasing numbers of borrowers unable to meet their obligations as scheduled. This eventually snowballed into a general financial crisis by September 2008, with systemically important financial institutions (SIFIs) across the globe in danger of insolvency.

Complete collapses in the global financial system and the global economy were averted in 2008 by unprecedented interventions by central banks around the world. Their massive injections of liquidity into the financial system, through a process called quantitative easing (QE), propped up the world economy and the prices of financial assets such as stocks by pushing interest rates down to record low levels.

As noted above, the methods for measuring the length and magnitude of bull and bear markets alike differ among analysts. According to criteria employed by Yardeni Research, for example, there have been 20 bear markets since 1928.

With storm clouds gathering for stock prices and the world economy alike, many market watchers say that prudent investors should act early to protect against an extended and worst-case market downdraft. Those concerned about the short term, or even the long term, should consider defensive portfolio rotations such as boosting cash and moving to bonds and other asset classes. Meanwhile, those stock investors inclined to ride out the storm should ask whether they are financially, and psychologically, prepared to endure drastic declines.