Stock market bears come in all shapes and sizes

A 20% decline or more from a market peak is broadly defined as a bear market for equities but, in our view, that’s an oversimplification. Understanding the history of bear markets and their variations can help investors better manage expectations and prepare for bear market environments like the one we’re potentially facing today.

The S&P 500 Index tumbled 19.78% from its high on September 20 through December 24, putting it within striking distance of a technical bear market. Stocks pulled away from the precipice with a dramatic rally on December 26, but it’s clear that investors are concerned and that the nearly 10-year-old bull market may be in jeopardy. Few―we weren’t among them—saw the magnitude of a correction coming so quickly. After all, the U.S. Treasury bond yield curve between the 2- and 10-year maturities hasn’t yet inverted (historically, a harbinger of a market peak), the U.S. leading economic indicators are still in solidly positive territory at 5.2% on a year-over-year basis,¹ and corporate earnings are on pace to increase 20% year over year for 2018.² History suggests that bear markets can occur without classic economic and corporate indicators flashing red, but there’s an important distinction: Bear markets that happen outside of recessions tend to be less severe than recession-driven bears.

U.S. stocks have experienced nine bear markets since 1950; a move lower from today’s levels could represent the tenth. Without a corresponding economic downturn, it would represent only the fourth nonrecessionary bear market over this nearly 70-year period. All things considered, that would be good news: Nonrecessionary bears tend to see drawdowns from prior peaks lasting 1.5 years on average, versus nearly 5 years for a recessionary bear market. The average drawdown in a nonrecessionary bear is also less severe: –27.4% versus –38.2% for a recessionary bear.

As we move into 2019, this context of bear markets is a key input into our view on asset classes in Market Intelligence for the year ahead. We’re lowering our view on equities to neutral from slightly positive, as some downside could persist, but we’re not moving our view to underweight equities, as we don’t yet see a recession on the horizon. In addition, we’re moving our underweight view on fixed income to neutral from slightly negative and favoring higher-quality parts of the bond market relative to lower-quality segments. The benefits of fixed-income diversification can be valuable regardless of the type of bear we may ultimately face.

Being confronted with a bear can be an unnerving experience for any investor. However, understanding bear tendencies may help investors better manage their way through the encounter. 

1 The Conference Board Leading Economic Index for the U.S., December 2018.

2 FactSet, as of 12/26/18.