With the S&P 500 now officially in a bear market, defined as a 20% decline from a recent peak, there are three ways we can assess how long a bear market might last and how severe the fall for stocks might be.
Of course, all approaches here are estimates, but they provide some indications of what might be in store for investors. These techniques involve historical comparison, valuation and economic analysis.
Most simply looking at history suggests that we are already some way into the bear market. An analysis by First Trust of bear markets since 1942 finds that the average decline in a bear market is -32%, which would correspond to the S&P&500 falling to around 3,300 or about another -12% from current levels, and the bear market lasting about a year. That would suggest the bear market would end around December 2022. Of course, keeping in mind that we’re already some way into a bear market.
Also, if you look at a different index, such as the tech-heavy Nasdaq, then the bear market started earlier and has fallen further, so the bear market may be closer to being over.
On the other hand, there were some nasty bear markets before the second world work, so including those in the analysis adds about a another 6 months to the average bear market and increases the average decline.
Either way if history is any guide, we could be around half way into a bear market in terms of timing, and over half way in terms of stock declines. There’s also about a 1 in 4 chance, that we’ve seen the worst of a bear market already, based on history as several bear markets never saw much worse than a 20% decline in stocks.
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So while history can’t provide complete comfort and does show examples of nasty bear markets with declines approaching 50% and bear markets lasting almost 2 years in most cases history is starting to suggest that things could get better from here. Most of the damage may have already have been done.
A Valuation Approach
Looking at valuation can provide some indication of when stock returns might start to improve. However, this assessment is more helpful on a medium term view of around 7-10 years. So this help us assess when the chances for positive stock returns improve, not necessarily when a bear market will end. For example, the S&P 500’s PE ratio is current approximately 19x, meaning that the market is currently paying $19 for every dollar of earnings from the S&P 500. That’s a lot less elevated than it was, and lower than a lot of valuations in recent decades. However, it’s still above the average long-term valuation level, which is around 15x. That suggests stocks could fall another 20% or so to hit average valuation levels. However, that’s a long term indicator. It suggests stock returns may be slightly softer over the coming years than we’ve seen in recent history, but still valuations are becoming quite a bit more attractive than they were. Though valuation doesn’t provide a firm floor to stock prices, valuations are a lot more attractive than they were.
An Economic Assessment
A final way to think about the bear market is from an economic standpoint. Here three main variables matter, though all are related. The bear market will likely ease when the market can look past a recession, see the Fed start to ease on rates hikes or expect inflation to moderate. Here it’s important to bear in mind that the market is quite forward-looking, the stock market often bottoms well before the economy does, and a lot of Fed hikes are priced in.
A lot of data here is actually quite optimistic, though it is clearly muddled. First off, the economy on a lot of metrics, such as jobs, is in remarkably good shape though perhaps starting to soften. This suggests that any recession could be quite mild.
Of course, inflation is the major concern, but, even here, there is some suggestion that we might have already seen peak core inflation earlier in 2022, especially as energy prices appear to be falling currently, even though inflation remains well above what policy makers target.
The market is also pricing in a lot of future hikes by the Fed, and changing course to a less aggressive approach is possible. For example, one policy maker called for a smaller hike at the Fed’s last meeting.
Finally if a recession does come in 2023, that suggests that the market may bottom ahead of that at some point in 2022. As such, given so much economic bad news is priced in already by the market the economy may actually fair slightly better than the market expects and that could set a floor on the bear market.
Of course, this all hangs on future economic data and Fed announcements, but if the incremental news begins to improve from here, then likely so will the markets. That’s not to offer much of an economic crystal ball, except to say that the current outlook is decidedly negative and things may improve.
So looking at a range of factors offers a moderate degree of comfort in this bear market. Stocks may well decline further from here, but it’s possible we’ve seen the worst of this bear market already in terms of the bulk of price declines.
Valuation levels suggest that returns from this point out over the next decade may still not be quite as good as a the very high returns seen for stocks in recent years, but that could still make stocks an attractive asset class going forward, relatively speaking, as has been the case for much of history for those with a long-term investment horizon.
Of course, much hinges on the economy, but a lot of bad news may already be priced in and even if a recession occurs, it could be relatively mild. Lastly, remember that market timing is tough. Stocks have shown robust returns over history, and investors who change course because of a bear market have often fared poorly, missing out on future returns.