Persistently high inflation, rising interest rates, and the ongoing Russia/Ukraine war weighed heavily across the markets during the first half of 2022. The S&P 500 fell 20%, turning in the worst first-half performance for any year since 1970. Meanwhile, bonds are on track to have their worst year since the Barclays US Aggregate Bond Index was created in 1973. Even cash, considered the safest of safe havens, has fallen in value, with inflation holding above 8% for much of the year.
It is official. The S&P 500 fell more than 20% from January’s highs and we are in a bear market. At a time like this, looking back to past bear markets can be instructive. No two are alike but we may be able to draw conclusions about the way the current bear market could play out.
That’s the number of bear markets since 1929. Even though we haven’t experienced an extended drawdown like this in more than a decade, they are actually quite common. A new one starts, on average, about every 4.3 years and is a normal part of the ongoing market cycle.
That’s the average market decline in a bear market. Through June, the S&P 500 is down just 20.5% from an all-time high on January 3, 2022. For historical context, not all bear markets are created equal. The market fell 56.8% in the Financial Crisis from 2007 to early 2009 and a terrifying 83.0% in the Great Crash of 1930, but just 20.6% and 20.7% in bear markets starting in 1948 and 1957.
The biggest factors in determining how far stocks fell in the past were recessions. Yes, the dreaded “R” word. Not every bear market is accompanied by a recession but those that are tend to be more severe. It’s unclear now if we are heading towards a recession or even if we’re already in one. Recessions are determined well after they start because of the time it takes to measure economic data. That said, it does feel like a recession is becoming more and more likely by the day.
Last year, the Federal Reserve expected inflation to fall back to normal levels on its own. That didn’t work, so this year the Fed is pushing interest rates higher to curb inflation and the effects are showing. The average 30-year mortgage rate has nearly doubled to 5.81% on June 30, 2022, compared to 3.22% just six months earlier, according to The Wall Street Journal. The thinking is that if borrowing is expensive enough, consumers and businesses will think twice before making large purchases and investments, thereby stifling demand and cooling inflation.
Fed Chair Jerome Powell has acknowledged that the Fed’s single-minded focus on bringing inflation down to a 2% target may contribute to causing a recession, so we can’t expect the Fed to bail out a contracting economy as it has when inflation was low.
And yet, some areas of the economy remain strong. Several headlines recently have touted large layoffs, particularly from technology companies, but overall, the labor market is still strong. The US unemployment rate is sitting near historical lows at 3.6% and there are 1.9 open jobs for every unemployed worker. If a recession occurs but we can keep unemployment from spiking above 10%, the economic contraction would likely be shallower than in many past recessions.
The average bear market lasts just under a year from the previous peak until the market falls to its lowest point. We are already six months into the current iteration and the bear market may already be closer to the bottom than we think. Falling stock valuations have already priced in a significant slowdown in corporate earnings but analysts paint a different picture.
A corporate earnings recession appears unlikely this year and next. Per FactSet, earnings for the S&P 500 companies are expected to grow 10.4% this year and rise another 9.5% in 2023. If these projections are even half right, current investor pessimism implies stocks are not being revalued because of earnings losses that can keep stock prices down.
That’s how often stocks recovered from the previous 21 bear markets. This sounds tongue-in-cheek but is the most important statistic to remember. Unless your life situation requires you to take money out of the market right now, your portfolio will recover. It is just a matter of time.
Either way, panic is never a good plan. It might be tempting to jump out of the market to wait for a bottom but that is riskier than staying invested. When bear markets stop falling, that extreme market volatility can work in your favor on the upside.
In the month following the bottom in the last three bear markets, stocks posted very large single-day gains. In 2002, after finally finding the bottom of the dot-com bust, the S&P 500 had single-day increases of 4.73%, 3.91%, and 3.50% over the following month. After reaching its lowest point in 2009, the index saw spikes of 7.07%, 6.37%, and 4.07%. Not to be outdone, the S&P 500 rebounded from COVID lows in 2020 with spikes of 9.38%, 7.03%, and 6.24%. Missing out on just one of these days can have long-term implications for a portfolio. Timing the market is nearly impossible. Time in the market is what’s most important.
That raises the important question: Is now the time to buy? Stocks can always get cheaper but they are definitely less expensive than they were in 2021—by about 25% to be exact. The forward price-to-earnings ratio has fallen to 15.9 on June 30, 2022, from 21.2 on December 31, 2021. While many of the stocks we follow look attractive, many of the highfliers over the past decade only look closer to finally being fairly valued at current prices. Even though many stocks are down over 50%, and in some cases much more, there is still a fair amount of risk. That’s why our focus is on buying high-quality companies with strong balance sheets instead of looking for what is most on sale. My mother taught me that just because the tag says “70% off” doesn’t necessarily mean it’s a good buy.
When one bull market ends, we usually see new companies take the lead into the next bull market. The brief bear market of 2020 really didn’t end the extended bull market that followed the financial crisis. As the world reopened following COVID shutdowns, the same large technology companies continued to post the best returns. Many of those high valuations were supported by low interest rates that kept borrowing costs low and put a higher valuation on future earnings. That period has likely come to an end and helps explain why value stocks have held up much better in 2022 than growth stocks.
For some balance, let’s look at historical bull markets. Bull markets tend to last nearly four times longer than bear markets (41.4 months vs. 11.3). After a loss of 37.1% in an average bear market, stocks need to rise 59% just to regain previous highs and the average bull market increase is over 135%.
Even after the recent rise in interest rates, rates remain significantly lower than the average of the last 40 years, especially those of the 1970s and 1980s. Interest rates at today’s levels or even slightly higher levels won’t necessarily preclude another bull market from beginning.
There is no standard definition of a bear market for bonds. Higher interest rates have driven down bond prices, and if rates remain at these levels, bond prices won’t recover over the next couple of years. Instead, because the coupons on the bonds we already own will remain the same, our return will come in the form of income. Additionally, any new bonds added to the portfolio will have higher yields, therefore paying a higher level of interest relative to their cost.
For the first time in a long time, bond yields look attractive. The 10-year Treasury yield nearly doubled from 1.52% at the end of 2021 to 2.98% on June 30, 2022. High-quality corporate bonds are yielding close to 5% on average. Lower-quality corporate bonds, also known as “junk bonds” or high-yield bonds, actually have high yields again, with rates closer to 7% or 8%, depending on the issuer.
High inflation has proven not to be “transitory” as most economists guessed and interest rates will probably remain higher over the next decade than we saw throughout the 2010s. That doesn’t mean markets won’t rise again. Instead, it means that the next bull market will look different from the last. We don’t know when the current bear market will end or which stocks will pull us out of it. Because we don’t know and because we don’t want to miss out, we will continue our disciplined approach by staying invested and staying diversified to ensure we reap the gains when the current bear market does come to an end … and it will.
This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.