Bear markets have been driven by any number of factors over the years, but regardless of the underlying cause they’ve all shared one unavoidable trait: They feel absolutely terrible when you’re going through them. That’s the case now, as the S&P 500 officially entered bear market territory on Monday.
Stocks fell sharply in the past two trading days after new inflation data sparked fear that the Federal Reserve might intensify its already forceful approach to taming surging consumer prices. The big fear is that the inflation fight could knock the economy into recession.
As nerve-rattling as market pullbacks can be, it’s important to place these moments in context. Whenever stocks retreat sharply, a common fear is that the root cause is unique. In other words, that whatever’s weighing on share prices is vastly different — and, by definition, more dire — than almost anything that’s gone before. That can make it hard to imagine an eventual market rebound.
It’s too soon to know how deep or lengthy the market downdraft might be, or whether a recession might take hold. But the S&P 500 has recovered from all previous bear markets. And while past results are not predictive of future results, the index has always gone on to new highs. That includes instances when Fed rate hikes were the direct cause of the market decline. Capital Group portfolio managers have navigated through numerous selloffs over the years, and they have deep experience in how to handle a period like this while positioning for a potential future rebound.
Here are three common characteristics of down markets that are important to keep in mind as the current downdraft unfolds:
Put simply, down markets are an inherent part of investing. At their most basic, they can wring out excesses that develop over time, such as unrestrained investor optimism or overvaluation in sectors that have gotten ahead of themselves.
As important, down markets perform a necessary function from a long-term perspective. By taking some air out of the balloon, they can open up buying opportunities in shares that had been overly pricey. Additionally, market setbacks can sometimes focus a spotlight on sectors that are either beginning to flash long-term investment potential or that have always had bright prospects but were overshadowed previously.
Capital Group analysts and portfolio managers are working diligently to identify sectors that may be vulnerable in today’s economic environment, as well as sectors that have long-term promise and suddenly attractive valuations.
While modest market downturns are fairly common, deep pullbacks have been relatively infrequent. The chart below depicts the frequency and length of downdrafts over the past seven decades.
Corrections — defined as a drop of 10% from a prior high — have occurred about once a year. In contrast, bear markets — a descent of 20% or more — have struck roughly every six years. On average, bear markets have lasted about 12 months — but their length can vary significantly. The pandemic-induced drop in early 2020 lasted just 23 trading days. By contrast, the bear emanating from the 2008 global financial crisis lasted 16 months, while the dotcom meltdown that began in 2000 persisted for 25 months. (Note that the chart below measures the market through May, and does not include the current bear market that became official on Monday.)
At the heart of the current selloff is fear that a recession may take hold in coming months if the central bank campaign to douse inflation takes too big a toll on the economy. At the moment, economic data has generally been robust. But markets always try to look ahead, and investors are therefore bracing for a potential softening later this year.
It’s impossible to predict the exact timing of economic contractions. However, it’s important to remember that, while bear markets and recessions have overlapped to an extent, they have not synced precisely. Bear markets have historically struck in advance of recessions. Between 1950 and 2019, equities tended to peak about seven months before the economic cycle.
And just as equities often led the economy on the way down, they also led on the way back up. The S&P 500 typically bottomed about six months after the start of a recession, and began to rally before the economy started revving again. In the current selloff, the S&P 500 peaked a little more than five months ago.
Thus, while it may be tempting to lighten equity exposure given the drop in share prices to this point, that runs the risk of pulling out of the market at an inopportune time. Instead of getting swept up in the emotion of the marketplace, it may be better to stick to the carefully created investment plan you have created with your Private Wealth Advisor.
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