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Beware of a Bear Market That Is More Than a Cub

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The US stock market is experiencing the worst start to a year in five decades. Technology stocks, long a favorite of investors, are collapsing. And yet investors don’t seem bothered. I count five bear or near-bear markets in my adult lifetime, and I don’t recall investors ever being this sanguine about a declining market.

One reason might be that, technically, this isn’t a bear market, which is generally defined as a decline of 20% or more from its most recent peak. The S&P 500 Index briefly dipped into bear territory on May 20 but rallied back by the end of the day. It’s down about 14% from its record high in January. So investors haven’t yet been bombarded with scary headlines that typically accompany a bear market.

Another reason could be that investors are becoming better at tuning out the market’s gyrations. With every selloff, they gain confidence that the market recovers eventually, even from harrowing declines like the dot-com bust in 2000 or the 2008 financial crisis. That may also explain why, by all indications, most investors hung on to their stocks during the pandemic-induced selloff in 2020.  

But there may be another, more concerning, explanation. Bear markets have become ever shorter over the past two decades, which may be giving investors the mistaken impression that stock market selloffs are brief, if uncomfortable, affairs. Consider the recent trend. It took the S&P 500 two and a half excruciating years to reach a bottom during the dot-com bust. The next downturn during the financial crisis lasted about 18 months from peak to trough. Then came two near-bear markets, a decline of 19.4% in 2011 that lasted five months and 19.8% in 2018 that lasted three months. And finally, the most recent bear market in 2020 lasted just 33 days.

A longer view of history, though, shows no reliable pattern around the duration of bear markets. The record back to 1928 reveals brief downturns sprinkled throughout, according to numbers compiled by investment strategist Ed Yardeni. The 1946 bear market, for example — a decline in the S&P 500 of 27% — lasted about four months. The one in 1957 lasted three months and was followed by two bear markets that each lasted less than a year. But those were followed by four long, brutal bear or near-bear markets from 1968 to 1982.

Interestingly, longer bear markets don’t necessarily mean deeper declines. For instance, the S&P 500 dropped 34% during the 33-day selloff in 2020, but it took nearly two years to decline 27% from 1980 to 1982. While the outcome may be roughly the same, duration makes a big difference. In 2020, investors barely had a chance to catch their breath before the market turned higher again. A multiyear selloff, on the other hand, is so painful for so long that many investors eventually give up.

It’s easy to underestimate the torment of an extended bear market if you’ve never encountered one. Neither millennials nor members of Generation Z were old enough to experience the dot-com crash, the most recent multiyear bear market. Reading about it isn’t the same as living it, obviously, but for the uninitiated, it’s worth reflecting on the anatomy of that downturn.  

It was a crash in three acts. The market peaked in March 2000, and tech stocks were the first casualty. The Nasdaq Composite Index declined 15% over the next six months while the broader market was flat. The first sign of contagion came in September. During the next six months, the S&P 500 dropped 27% while the Nasdaq tumbled an additional 61%. By April 2001, it looked as if the worst was over given the severity of the Nasdaq’s decline and that the market had turned higher.    

It didn’t last long. In late May, stocks turned lower again. The S&P 500 dropped an additional 26% and the Nasdaq declined 38% over the next four months. By the fall of 2001, the pain was palpable. Stock portfolios evaporated, and the red on Wall Street spilled into the broader economy, sending it into recession.  

Surely, that was the end, or so it seemed when the market rallied through late fall and winter. Then came the knockout punch. From March 2002 to the bottom in October, the S&P 500 gave up an additional 34% and the Nasdaq dropped 41%. When it was all over, the S&P 500 was cut in half, down to 777 from 1,527 when the bear market began, and the Nasdaq had given back nearly 80% of its value.  

There’s no way to know in advance if the market has already bottomed or is on the precipice of a longer decline, even in the face of obvious headwinds such as high inflation, tighter monetary policy and war in Ukraine. But one thing is certain: Stocks were vulnerable during the dot-com era because valuations had become absurdly high, leaving them plenty of room to reprice. When 2000 began, the S&P 500 traded at 28 times forward earnings, well above its average, which is closer to 18 times.  

The market wasn’t that expensive again until late 2020, when its valuation floated back up to 27 times. It has since contracted — the S&P 500 now trades near its historical average of 18 times. But the market has a habit of overcorrecting. During the dot-com bust, the S&P 500 bottomed at 16 times, and it dipped closer to 11 times during the financial crisis. So it has further room to fall, particularly if earnings disappoint.  

Whatever happens, investors know they must hang on because the market will eventually climb to new highs, as it always has. But the longer this downturn drags on, the harder it will be.   

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Nir Kaissar is a Bloomberg Opinion columnist covering markets. He is the founder of Unison Advisors, an asset management firm.

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