Key Questions: Stocks Have Entered a Bear Market. What Do Investors Need to Know?
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History tells us a bear market generally precedes a recession, but the bottom in the market also typically precedes the bottom in the economy.
Navigating 2022 has been difficult for investors as virtually every financial asset has lost value. Most notably, stock prices and bond prices have both posted double-digit declines and the S&P 500 officially entered bear market territory on June 13.
A decline of at least 20% from the prior market peak is commonly referred to as a bear market. By June, the index had declined by more than 20% since its January peak, leading many investors to wonder how long the bear market will persist and what type of action may be needed.
While no one can predict the intensity or the duration of a bear market, historical analysis provides some guidance. Since the 1800s, the average peak-to-trough for a bear market has been a decline of 37% and has required 58 months to return to the previous high. That said, there is considerable variability around these averages as prevailing economic conditions at the onset of a bear market can have a major influence on what happens next.
Not All Bear Markets Are Alike
Structural bear markets feature deeper declines (50% or more) and have lasted twice as long as the average bear market. These bear markets are caused by structural imbalances precipitated by financial excess such as the real estate bubble in the mid-2000s.
Other bear markets, such as the one following the immediate aftermath of COVID-19, are painful but relatively short-lived. In early 2020, the S&P 500 crashed 34% within a month’s time, a breathtaking decline. But within six months, the market had exceeded its prior peak, well before the economy had fully recovered.
Today’s bear market may likely fall somewhere between these two episodes. Certain elements of excess are apparent, but structurally the economy is on strong footing. Yet persistently high inflation will likely cause interest rates to rise further, potentially limiting stocks from quickly ascending to new highs in the near-to-intermediate term.
Perception Versus Reality
The intensity and duration of a bear market can also be attributed to the perception of an upcoming recession, if there is one.
Market participants may sell assets sharply on the potential for a recession, only to find out that the economy weathered the storm. This scenario may apply to our current environment. There remains a slight possibility that inflation could cool in the coming months resulting in the Federal Reserve tightening less than anticipated. In this case, the current bear market could be less intense and have a shorter duration than indicated by the historical averages.
Historically, the odds favor bear markets resulting in recessions. In most past instances, a bear market has preceded a recession and has indicated that the economy was already in a recession when the bear market started.
Clearly, moving toward a recession is a negative, but there is a silver lining for investors. If a bear market precedes a recession, then the bottom in the market also typically precedes the bottom in the economy. The takeaway is that the worst losses in the market likely are already behind us as the economy bottoms, thus selling when the economy is bottoming is not the ideal approach for an investor.
Investors should understand these dynamics and be selective in bear markets rather than indiscriminately selling stocks because of weaker economic conditions. Defensive sectors such as consumer staples, health care and utilities frequently have outperformed the broader market throughout bear markets so recessions in these sectors generally are resilient to economic shocks.
Similarly, higher quality companies have a tendency to lead in weaker markets as investors gravitate toward companies with stronger balance sheets and competitive advantages and business models. Our Investment Center has long favored such companies within our internally managed equity strategies.
Bear markets can be discouraging, but it is important to stick with your financial plan and goals.
Bear markets have come and gone in the past; over the long term, those who have stayed invested have ended up far exceeding the losses experienced during the bear markets. Market timing is difficult and staying invested while following your financial plan is the only way to ensure you catch the recovery and the start of the next bull market.
Remember the words of Sir John Templeton: “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.”
For more information, please contact your advisor.
About Michael Sroda
Michael Sroda is a Senior Lead Research Analyst on the Equity & Fixed Income Research team in the Key Private Bank Investment Center. Within the Equity Research team, he is responsible for the coverage of Financials, Real Estate Investment Trusts, and Utilities. His Fixed Income Research responsibilities include providing credit support to both the Municipal Investments team and the Taxable Investments team, as well as the surveillance of all individually-held fixed income investments at Key Private Bank. Prior to joining Key in 2009, he worked as a Financial Reporting Analyst at National City Bank. Michael holds a Bachelor of Business Administration (BBA) with a concentration in finance from Kent State University and received his Master of Business Administration (MBA) from John Carroll University. His professional memberships include the National Federation of Municipal Analysts (NFMA), Chicago Municipal Analysts Society (CMAS), and CFA Society Cleveland.