On March 11, which some are now calling Black Thursday, the U.S. stock market entered a bear market. What does this mean and what should investors expect going forward?
A bear market has a technical definition, and is not necessarily predictive. If stocks decline 20% from their recent high then you’re in a bear market. Of course, on that definition, once stocks have fallen 20% there’s no reason they should continue to go lower. Still, further declines can often occur. What should investors expect next?
Researchers have found that one hallmark of bear market is high volatility when compared to bull markets. Erik Kole and Dick van Dijk of Erasmus University of Rotterdam have examined many aspects regime change between bull and bear markets. They found volatility to be much higher in bear markets. This week underlined that conclusion, of course. We saw two drops that triggered market circuit breakers. Every single trading day this week saw an up or down move of close to 5% for the S&P 500, sometimes almost double that. Those are the sort of moves we typically see over a month. Yet, each move occurred every single day this week.
Of course, bear markets shouldn’t be expected to sustain volatility at quite this extreme level, but compared to the recent bull market it’s pretty normal to expect volatility to remain elevated until the stock market regains a more positive trajectory.
No Quick Fix
Though this past week may have felt like a long one for anyone involved in the markets, bear markets are seldom quick. Yes, we have seen a rapid 20% decline in the stock market, but any real rebound for markets could take longer if history is any guide. We are under a month into this bear market at this point. The shortest bear markets in history have been 3 months long. Longer bear markets can last 1-2 years. Much depends on the trajectory for the U.S. economy, and specifically the risk of a U.S. recession. Stock market losses can bottom out around 60% in the most extreme case, which would imply a halving of the markets from here. However, most cases see declines of closer to 30%, which would be a little more than a 10% from here. Of course, there’s no reason this bear market has to respect the parameters of history.
Bear markets also often occur around economic recessions. Other recession warnings are flashing too as yield spreads increase, the yield curve inverted last year and many expect upcoming unemployment data to be dire. The stock market itself is a recession predictor too when it falls, though a less reliable one.
So while we don’t know if a recession is coming, or if we’re in one already, given the bear market the odds on a 2020 recession just went up somewhat. If that happens, then the bear market could end up being deeper.
So this bear market seems likely to last a little longer and volatility won’t recede too quickly either if history is informative. However, the next key question is whether we see enough disruption to prompt a recession, that could mean another leg down for stocks.