Assessing the Current Bear Market – Cyclical or Structural?
Goldman Sachs recently published a research piece looking back at bear markets since the 1800s. Based mostly on duration and damage, Goldman divides stock bear markets into three groups – event-driven, cyclical and structural. Triggered by sudden exogenous events like war or pandemics, event-driven bear markets are the shortest and least damaging of the three with an average duration of 8 months and an average peak to trough loss of 29%. Driven by normal business cycles, cyclical bear markets have an average duration of 25 months and average peak to trough losses of 31%. Structural bear markets, caused by structural imbalances, are the longest and most damaging of the three with an average duration of 42 months and an average peak to trough loss of 57%.
Looking at more recent bear markets can give a more relevant picture in assessing the current bear market. The Covid bear market was a quintessential event-driven bear market, which lasted just one month from February 2020 to March 2020 with a peak to trough loss of the S&P 500 Index of a relatively mild 34%. On the other end of the spectrum, the GFC (Great Financial Crisis) bear market was a text-book structural bear market. Caused by the structural deficiency of excessive speculation and inadequate capital in the banking system, that bear market lasted 17 months from October 2007 to March 2009 and its peak to trough loss was a whopping 57%, wiping out all the gains of the previous bull market.
So how about the current bear market? Starting from early January, it has lasted a little over 6 months so far with a peak to trough loss currently at 23%. Obviously, this is not an event-driven bear market and Goldman currently puts it into the cyclical bear market camp. This makes sense since the current bear market is still unfolding, and you can only draw a definitive conclusion afterwards when the bear market is over. Below is our assessment of the current bear market.
The current bear market is facing two structural challenges – the reversal of the decade long, super-easing monetary policy and deglobalization. The first challenge is the obvious one with immediate impact. As inflation is surging, the Fed has had to reverse its decade long, super easing monetary policy and raise interest rates in a hurry along with quantitative tightening. As a result, stock valuations have plunged, especially growth stocks. Stock market losses so far have been almost entirely driven by multiples contraction. However, the damage to corporate earnings has yet to materialize but is likely to emerge soon. After all, the decade long, super-easing monetary policy not only helped lift stock market valuations but also boost corporate earnings. The reversal could be equally painful – what goes around comes around. The second challenge (deglobalization) is less obvious but could be more long-lasting and potentially more damaging. The unofficial debut of deglobalization is widely considered to be 2018, when the U.S. and China started a trade war by imposing tariffs on each other’s goods. Over the years, the trade war has increasingly evolved into a quasi/semi cold war. The Russian invasion of Ukraine this year only speed up this deglobalization trend and a new cold war is all but a reality. Corporations, especially multinational companies, have increasingly become unintended victims of this new cold war. A world full of geopolitical tensions is not good for stock markets – stock markets had been struggling for decades during the first cold war and only took off after the cold war finally ended in late 1980s.
As the current bear market is still unfolding, regulators and politicians will play a significant role in determining its final fate. The Covid bear market ended quickly thanks to the Fed’s decisive intervention. Otherwise, it could have evolved into a structural bear market with the economy plunging into a depression.
It’s important to remember, bear markets are not bad for the long-term prosperity of the stock market as they often help fix some structural out of whack valuation problems in the economy. After the GFC, U.S. banks have become some of the safest in the world and the ensuing decade-long bull market enriched a generation of investors.
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