History Is No Mystery: Part I

April 18, 2020

Can History Help Us?

Do past stock market cycles tell us anything about where the market is heading? Or is it really different this time? While I have never come across anyone in my 30 years of investing that can consistently tell us where the stock market is heading over the next year, history can help. Although every bear market is distinct and driven by different forces, they also share a lot of similarities that provide valuable information when combined with forward looking estimates of value. In this two-part series I look at the bear and bull markets since the Great Depression as guidance for where the markets are going.

History Is No Mystery

The cycles are based on the S&P 500 stock index, with daily data back to 1928. I used the National Bureau of Economic Research for the recession data, as it sets the official dates for the start and end of U.S. recessions. The work shows 13 major bear markets since 1928 (a drop of 20% or more), 10 of them accompanied by recessions/depression[1]. Not surprisingly, the data gives us a mixed message on where we are heading.

Part I: The Bears

Chart 1 shows the 13 bear markets in blue, with the labels referring to the year the market peaked. For example, in 2007 the S&P 500 peaked in October, then reached its low in March 2009, dropping 55%. The 2020 bear market is in orange, with the low so far on March 23. I have also included data for the median[2] for all the bear markets with recessions in grey and for all the bear markets with recessions since WWII in black. What this chart shows us is that the extent of the current decline, a 35% drop, is typical, and in line with the median bear market with a recession (black bar). Most bear markets have declines between 20% and 40%.

Chart 1

Source: Yahoo Finance, National Bureau of Economic Research, J.P. Morgan Asset Management

Chart 2 shows the same bear markets but measures the decline as a percentage of the increase during the previous bull market. For example, in the “Tech Wreck” of 2000 the market retraced 62% of the prior bull market from 1990 to 2000. Chart 2 tells a different story from Chart 1, as the current bear market has only retraced 44% of the bull market that ran from 2009 to February of this year. This is less than either the median retracement of 57% or the median post WWII retracement of 70% for bear markets with recessions. Of the prior 13 bear markets, all but 1 (1956) retraced about 50% or more of the prior bull market.

Chart 2

Source: Yahoo Finance, National Bureau of Economic Research, J.P. Morgan Asset Management

Chart 3 shows how many months each bear market lasted. This is where the current bear market really looks different from history. If the March 23 low holds, it would have been the fastest decline of this magnitude, falling 35% in just over a month. The only other quick decline of a similar magnitude was the 1987 bear market, and that took 3 months. The 1-month decline is noticeably short compared to the medians, which are both around 18 months.

Chart 3

Source: Yahoo Finance, National Bureau of Economic Research, J.P. Morgan Asset Management

The table below summarizes the lows based on the medians and in the parentheses what percentage decline from the peak that represents. The numbers shown in the table are not a forecast, just an indication of what might happen using history alone as our guide. As you can see, only the third column shows that the low may already have been reached.

S&P 500

So, What Now?

History doesn’t tell us the answer, but it gives us a range of possibilities. Putting this all together, my take is that the lows we experienced on March 23 are likely the lows for this bear market. However, given the short duration of this bear and the uncertain economic environment, the markets won’t revisit the previous highs for many months to come.

The Fun Part

In Part II I will look on the bright side by reviewing all the bull markets and what they may tell us about the next major up leg in stocks.

In the meantime, invest wisely,

Dave Schaffner

Principal, Wayfairer Capital Management Ltd.

[1] The small number of observations, in this case bear markets, results in the average and median having a high degree of estimation error. We may need to wait another 90 years or so to get enough observations!

[2] The value at the midpoint of the bear market observations, such that there is an equal probability of a bear market being larger or smaller than the value.