Waking The Bear

Here we go again with another US bear market, at just over two years since the end of the last one. We are all familiar with who and what has produced this self-inflicted wound. Yet given the high valuation of the US market (see Can You esCAPE US Stock Returns?), it was only a matter of time until something (or someone) came along to spoil the bull market party. To get an idea of what the bear coming out of hibernation may look like, and the implications for an investment portfolio, I have updated the data and charts from the May 2022 blog Barely A Bear.

Bull Markets: 2022 Was A Smaller One

As you can see in Chart 1, the latest US (S&P 500) bull market that started in October 2022 and ended in February was historically the third smallest bull market in terms of duration (2.4 years) and percent increase from the bear market bottom (76%). This isn’t surprising. As covered in my blog Riding the Bull, the starting cyclically adjusted price earnings ratio (CAPE) of 27 was higher than any of the CAPE lows of the previous bull markets. It was even higher than the median CAPE of 22 at the bull market highs. As a reminder, there is a strong negative relationship between the level of the CAPE and the return over the next 10 years. In other words, a high CAPE translates into a low 10 year return.

Chart 1

Bear Markets: 2025 So Far

In chart 2 I added the data for the US market selloff up until April 10. The current intra-day low for the S&P 500 was on April 7. It has only been 2 months since the peak of the market in February, and the decline from the intra-day peak to intra-day low has been 21%. This compares to the median decline of 35% over 14 months in all bear markets since 1929.

Chart 2

Portfolio Implications

I wholeheartedly agree with what Howard Marks, the co-founder and co-chairman of Oaktree Capital Management, wrote in his latest memo Nobody Knows (Yet Again):

“There’s absolutely no place for certainty in the world of investing, and that’s particularly true at turning points and during upheavals. I’m never sure my answers are right, but if I can reason out what’s most logical, I feel I have to move in that direction.”

Given Howard’s sage advice, my reasoning is that what it is most logical (given Trump’s illogical reasoning) is that the tariffs/trade war will persist for longer than we would like. In that scenario, the tariffs (and the uncertainty around their level and implementation) will lead to higher inflation, lower consumer spending, and lower business profitability in the US.

What does this scenario mean for a portfolio? First, given the median length and decline for bear markets shown in Chart 2, market weakness will likely persist as the effects of the tariffs/trade war work through the US and global economies. This will take weeks and months, not days. But remember it is extremely hard to sell stocks now and try to rebuy them at cheaper prices later. Instead, focus on reinvesting any extra cash into stocks with a view to holding those stocks for a few years. Second, despite the decline to date in US stock prices, they are still overvalued (using the CAPE methodology) relative to Canadian, international, and emerging market stocks over the standard asset allocation horizon of 5-10 years. So, borrowing from Howard Marks, I would move in the direction of underweighting US stocks in favour of Canadian and international stocks.

Invest wisely,

Dave Schaffner, CFA

Principal, Wayfairer Capital Management Ltd.