Are we in the beginning of a bear market?

Searching for signals.
Searching for signals.
Image: Reuters/Kai Pfaffenbach
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The best financial advice is to buy low and sell high. The problem, of course, is that it’s impossible to identify highs and lows until after the fact.

Last year, I went to a party full of bankers, and every one I spoke to told me they had pulled out of the market. And they really meant it: their retirement savings, their brokerage accounts, and everything else was converted into cash. 1 They told me the market was ready to crash. Since then, stocks are up nearly 10%. Perhaps they are right, but just off on the timing. After one of the longest bull runs in history—nine years and counting—we could be at the start of a bear market. Monthly stock returns have been negative for the past three months.

What is a bear market?

What defines a bear market depends on who you ask. Broadly speaking, it describes a turn in sentiment among investors, and a widespread sense of pessimism that leads to falling stock prices. During a bear market, prices fall by a significant amount over an extended period of time.

Identifying these episodes requires a more specific definition. The popular Wall Street rule of thumb is when stock prices fall by 20% or more. This is more extreme than a “correction,” or a 10% drop in prices.

Economists prefer even more precision. A 2002 paper by Adrian R. Pagan and Kirill A. Sossounov attempted to measure a bull or bear market the same way economists measure expansions and recessions. A recession is, to simplify greatly, two consecutive quarters of negative GDP growth. In that spirit, Pagan and Sossounov defined a bear market as at least four months of negative returns or a 20% drop or more in a single month.

During the last bear market, from 2007 to 2009, the S&P fell by more than 50% over a 17-month period. It was an exceptionally severe downturn, historically speaking. Overall, the economists estimate bear markets tend to last less than 15 months, while bull markets tend to persist for more than 25. What’s more, returns during bull markets tend to grow more than they fall during bear markets. If you combine a bull and bear market and consider them as part of one cycle, stock prices normally end up higher at the end of it.

Are we in a bear market now?

It is impossible to know for sure if, after such a long bull run, we are now in the early stages of a bear market. Three straight months of negative returns for the S&P 500 could indicate that the US market is starting to dip its toe in bear territory. Or, markets may simply be more volatile than in the recent past, bouncing up and down as they used to do more regularly. This does not necessarily mean that a sustained downward trend has taken hold.

So far, the market is down about 9% from its high in January. At least by Wall Street’s rule of thumb, we have a ways to go until we can call it a bear market.

Those bankers I met last year will probably regret their decision to sell everything. Most people who try to time the market lose more money missing out on gains than they save avoiding declines.