The Greek historian and general Thucydides famously said, “History is philosophy teaching by examples.” That brilliant observation came to mind when we were thinking about how history can be a valuable guide for navigating volatile market environments.
Since we officially entered a bear market on March 11 of this year, we’ve begun thinking about what long-term investors can look to as they search for a path forward in a bear market. While not all bears are alike, there are some common lessons to be learned from how other bears have progressed. Here are some frequent questions we’re being asked, and our responses based on our reading of bear markets throughout the 20th and 21st centuries.
Question 1: How often do bear markets happen?
We know that bear markets are relatively common occurrences in market history. Despite the fact that U.S. stocks, as measured by the S&P 500 Index, have delivered an annualized total return of 10.2% since 1926, it is still true that, over the past nine-plus decades, there have been:
- 24 bear markets, as defined by market declines of 20% or more, a frequency that translates into one every 3.5 years
- 12 major market bear markets that were associated with recessions, which means that major, multi-month bear markets came, on average, every 7.5 years
If we examine the current decline with the five previous worst bear markets of the past 100 years (the Great Depression, the 1987 Crash, the 1991 Gulf War, the tech bubble bursting, and the 2008 global financial crisis), the current peak to trough decline of 34% ranks bigger than only the 1987 decline and the 1991 decline. The other three – during the Depression, the “tech wreck,” and the global financial crisis – saw even bigger market drops. (As noted below, as of April 7, 2020, the most recent market peak occurred on February 19, 2020 and the trough on March 23, 2020.)
Question 2: How big are the declines in bear markets?
On average, since 1926, bear markets have seen stock prices fall, on average, 36%. Deeper recessions are associated with steeper declines. For instance, the peak to trough decline in the S&P 500 in the 2008 financial crisis saw close to a 52% fall in stock prices, whereas in the early 1980’s, the double dip recession the U.S. experienced drove stocks down only 27%.
Question 3: Where does today’s decline rank?
If we’re dating the recent high of the S&P 500 Index to February 19, 2020, when the index closed at 3,386, then we’ve experienced a peak to trough decline through March 23, 2020 of 34%. That ranks already as the sixth biggest bear, out of a total of 12 major bears dating back to 1926. It’s not the worst, but we’ve certainly already surpassed many of the shallower bear markets we’ve experienced.
Question 4: How long does it take to recover from bears?
Typically, the average time to recovery has been 4.4 years or 1,100 trading days, with recovery defined as the time required for stocks to emerge from a bear market and reach their prior high. At first glance, this may seem like a long time, but remember, stocks have historically gone up more frequently than they’ve gone down. On average, markets were positive 75% of the calendar years, dating back to the start of the 20th century. While bear markets are painful, the losses historically haven’t been permanent, and the stock market has been one of the best ways to grow invested assets, even with these periodic setbacks.
Question 5: What happens if you sell in the middle of a bear?
Investors that sold during the middle of bear markets typically took longer to get back to their prior peak than investors who stayed the course. We looked at the peak-to-trough period for a bear market and made a hypothetical investment in a basket of stocks that matched the index at the exact midpoint of the drawdown. So, during the financial crisis, the market peaked on July 19, 2007 and infamously bottomed on March 9, 2009. If an investor sold halfway through the decline in 2008, it took them an extra two years to recover their initial investment versus a buy-and-hold investor. That additional two years was on par with the recovery time needed for investors who exited the markets mid-way through other periods of decline.
Question 6: What happens if you buy in the middle of a bear?
The results for investors who embraced the opportunity that a market decline presents were encouraging. Over the five major bear markets mentioned earlier, investors lost on average 38% between the time they invested and when the market actually hit its bottom. That degree of loss seems painful. Still, the encouraging part was that 5 and 10 years later, on average, an investor had earned 26% and 110% cumulative returns, respectively. Even when investors got the timing wrong, the math worked out for their portfolios over the long term if they added to equity positions halfway through a bear market.
Question 7: What happens if you wait for better economic data?
Economic recessions usually end long after markets have rebounded. For instance, in the 2008 financial crisis, subprime mortgage defaults peaked in March of 2010. If you had invested $100,000 at the peak of the market in 2007 (October 9) and sold out halfway through the bear of 2008 on October 10, 2008, and then waited until you saw subprime defaults declining before getting back into the market with the diminished amount you had, it would have taken until April 2, 2013, or 1,379 trading days, to get back to your original $100,000 investment. This is far worse than a buy-and-hold strategy. For anyone who held on to their investment, it would have taken about 250 fewer trading days – 1,125 – to get back to their original $100,000 investment.
Question 8: Where does the recent rally off the bottom rank over bear market history?
At the time we’re writing this on April 8, 2020, markets have rallied off of their lows hit on March 23, 2020. The market’s performance through the past two weeks has actually been the second-best rally during a bear market in history, beaten only by a rally of nearly 20% in November of 2008 during the heart of the global financial crisis. Typically, rallies of 15% or more during bear markets have seen negative performance three months later, but after one year they have almost uniformly delivered positive returns. Bear markets, on average, have historically lasted around 14 months.
Question 9: What happens if you try to trade in and out of bear markets to avoid losses?
We think trying to time investment decisions on the basis of market moves is a fool’s errand. The risk is that you are out of the market during its best days, which often come quickly and unexpectedly. If an investor missed only the S&P 500’s 10 best days in each decade going back to 1930 through 2019, the total return for that investor over the past 90 years would have been 4.7%, on annualized basis. The annualized return for a buy-and-hold investor over that same period was 9.8%.
That’s a difference of 5.1% annualized for investors who held steady through periods of volatility and more than double the return what missing the best days achieved. For perspective, a $10,000 initial investment would have only grown to $639,000 if an investor missed the 10 best days every decade. But that same investment would have grown to $44 million in a buy-and-hold strategy.