Do not expect a recovery from this bear market until next year
After a difficult week for investors, here’s some good news. Bear markets, like pandemics, don’t usually last that long. We can leave it to the epidemiologists to work out how long the coronavirus will take to burn out. But we can make some calculations about the likely length of the bear market it has triggered this week, and when it is likely to be safe to start buying again.
A Goldman Sachs analysis of every bear market since 1835 tells us that the very worst ones, caused by deep structural imbalances, can last for more than three years. But the shortest ones, caused by a war or a natural disaster, are typically over after nine months. In truth, this one is going to be somewhere between – which means it will drag on for most of this year, but should be done by the time 2021 rolls around.
Ironically, if it could have just staggered on until Monday the bull market would have celebrated its 11th birthday. In terms of length, it was one of the strongest on record, and even if the gains were not as spectacular as some of its predecessors – the epic bull runs of the Twenties and Nineties easily out-paced it – they were still pretty good. The S&P 500 was up by 269pc from 2009 to 2020 and, with the notable exception of our own FTSE 100, the rest of the major indices were not too far behind.
Even with yesterday’s rally, however, it is now definitely over. On Thursday, the equity markets saw their worst trading day since way back in 1987, with the FTSE 100 losing 11pc and the S&P 500 off by 10pc.
That was enough to take them into a bear market, defined as a 20pc drop from the peak – by Friday morning the S&P 500 was 26pc down on its all-time high recorded less than a month ago. So how far might equities fall, and how long could it be before a recovery gets under way? The Goldman Sachs analysis back to 1835 came up with some useful historical parallels.
The key point is what triggers the sell-off. What the bank defines as an “event-driven” bear market – triggered by a war, earthquake or, indeed, a virus – typically sees a 29pc drop in the markets, and lasts nine months with another 15 months to recover in nominal terms. An example? The Cuban missile crisis of 1962, which, understandably given the world could easily have ended, triggered a sharp but relatively brief sell-off.
A “cyclical bear market”, defined as one triggered by rising interest rates, a recession and a fall in company profits, is far more serious. Typically one of those will witness a 31pc fall in equity prices, last for 27 months and take 50 months to get back to where it started.
The most serious of all is a “structural bear market”, driven by asset bubbles and financial imbalances, which typically sees a 57pc drop in prices, lasts 42 months and takes 111 months to get back to its starting point.
We saw one of those in March 2000 with the bursting of the dotcom bubble, and then again in October 2007 with the global financial crash.
Here is the important question. What kind is this? It makes a big difference. If it is an event bear market, then we should have seen the bulk of the price falls and the recovery will start at the end of this year. If it is a
‘We are likely to see markets fall again by as much as they have in the last month before a bottom is reached’
structural downturn then we still have a lot of pain ahead – another 30pc at least off the Dow and a similar amount off the FTSE 100, which could take it down to 3,500.
In truth, it will be somewhere between the two. There can be no question that the coronavirus is an external shock. It is something that has appeared out of nowhere that no one really expected or could plan for, and which is going to inflict a lot of pain on the global economy. In that sense, it is a lot like the Cuban missile crisis or the Iraqi invasion of Kuwait in 1990. The markets tank but as the event comes under control, and the worst fears turn out to not be realised, the recovery is relatively swift. Even if the virus does keep spreading, so long as mortality rates remain relatively low and medical systems can cope, the damage need not be lasting.
The trouble is, it also comes at the tail-end of a long bull market during which asset prices had been artificially inflated. In the 10 years since the financial crisis, we have seen interest rates stuck either at 300-year lows or so close to them that it makes no difference; we have seen round after round of printed money, and we have seen a bubble in technology stocks that took valuations well beyond anything that could be reasonably justified. Anyone who thinks equity markets and the global economy were in perfect shape before the coronavirus outbreak is deluding themselves.
The net result? This looks like a structural bear market, even if it has a specific event as its trigger. The last two, in 2000 and 2007, saw the S&P 500 drop by 49pc and 57pc respectively. If that is the outcome, we are likely to see the markets fall again by as much as they have in the last month before a bottom is reached. Investors may want to start buying along the way. But they shouldn’t expect a recovery until well into 2021.