By Guest Blogger Ryan Lewenza
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It’s official…we just experienced the first bear market – defined as a 20%+ drop from a previous peak – since the 2008/09 financial crisis. In the fourth quarter of 2018 we got within a hair of a 20% decline, so from my perspective that was a bear market despite it not meeting the industry standard of one. That said, with this market carnage, indiscriminate selling and many people/investors just basically losing their minds, where do we go from here? Today I’m going to review past bear markets to see if we can glean any valuable insights into this question and I’ll provide the indicators I’m monitoring to help me determine when this sell-off may be over.
Let’s begin with a look back at the previous bear markets in the table below. Again a bear market is defined as a 20%+ peak-to-trough decline, which I view as arbitrary and simplistic, but nonetheless let’s focus on these specific occurrences.
Since 1945 there have been 12 “official” bear markets. Here are the key takeaways from them:
- The average bear market decline is 31% while the median decline is 29%
- As of March 12th the S&P 500 is down 27% so we’re pretty close to the average decline
- More recently the S&P 500 declined 49% in the 2000 tech crash and 57% during the 2008/09 financial crisis. I do not believe these are good comparables since: 1) the S&P 500 was extremely overvalued at a 30x P/E in 2000 versus a recent peak in February of 22x; and 2) this is not a financial crisis as US banks are in much stronger shape today so we don’t see a potential economic recession bringing down the banks, leading to a negative feedback loo
- The 1987 stock market crash saw the S&P 500 decline 34% but not widely known, posted a 5% total return for the year. Personally, I think this may turn out to be the best comparison for this current downturn
- On average bear markets last 13 months. We’re only 2 months in so this suggests we have more time to go before this ends
- Finally, I then looked at how long it takes to get back to even assuming you were the worst investor in the world and invested right at the peak of every bull market. On average, it takes three and a half years to get back to even. Again this assumes you’re the worst market timer in the world
For me this analysis points to a potential silver lining. With the S&P 500 already down 27%, and the average decline being 31%, it suggests we’re getting closer to the bottom. Now I’m not making that bold call yet, as the headlines remain incredibly negative, infections should continue to rise in US and Europe, and we are likely to see a global recession in the coming quarters.
But are we 50%, 75% or more through this bear market? Time will tell but I do believe we have already endured a good chunk of this bear market and I believe strongly that we will get through this and we’ll look back at this time as a buying opportunity.
US Bear Markets Since 1945
Source: Bloomberg, Turner Investments
Now on to what I’ll be focusing on to help me determine when we may be through the worst of this.
First, we need to see a peak in infection rates. According to Johns Hopkins data, cases of new infections in China look to have peaked, however rates in the US and Europe are heading higher. Our hope and expectation is that infection rates will peak in North America and Europe in the spring. The next few weeks and month will be key!
Second, we need to see the US yield curve steepen. With fears the virus will lead to slower economic growth and possibly a recession, US government bond yields have plummeted, resulting in another yield curve inversion. This suggests a recession is coming. If there is one I believe it will be short lived with economic growth recovering once the virus is behind us. The Fed is starting to cut interest rates and is likely to cut further so this may help address the inverted yield curve.
US Yield Curve
Source: Bloomberg, Turner Investments
Third, I would be looking for attractive valuations for stocks. Currently, the S&P 500 trades at a 16.2x P/E ratio, which is well off from its recent highs of 22x and close to its long-term average. This is an interesting level since the S&P 500 has bottomed at this level three times since 2015 (see chart). Basically this level has created a floor in stock prices for the last 5 years. Let’s hope it holds.
If it doesn’t the S&P 500 would probably drop to a P/E of 13-14x level, which would then likely be a strong buy.
S&P 500 P/E Ratio
Source: Bloomberg, Turner Investments
Lastly, I would need to see a turnaround in the technicals. I would like to see: 1) the S&P 500 rise back above its 50 and 200-day moving averages; 2) the Hang Sang/Shanghai breakout; and 3) the airlines and cruise ships rally.
What I do is more of an art than a science so I don’t need all of these things to come together, but a combination of a few of these factors would likely make me more bullish. For now it’s time to sit and chill. No sudden movements!
Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.