On Average, Bear Markets Stink


Stocks have slumped on renewed weakness in oil prices and worries about a global economic slowdown, putting the Dow Industrials and Dow Transports within striking distance of their Jan. 20 closing lows. The widely followed S&P 500 Index closed below its Jan. 20 closing low before rebounding modestly.

Investor sentiment is unusually pessimistic, and a near-term bounce from current levels would not be surprising. But the primary trend remains in the bearish camp under the Dow Theory, and history suggests stocks still have considerable downside risk in a true bear market. For now, as a partial hedge, our buy lists have 21.4% to 26.4% in a short-term bond fund.

Good news and bad news

The S&P 500 Index has suffered 25 bear markets since 1929, or roughly one every 3.4 years, according to Bloomberg. A bear market — defined as a decline of at least 20% without a 20% rally — has lasted 10 months, on average. The average bear market has brought a decline of 35.4% in the S&P 500, with half bringing declines of at least 33.5%.

The good news is that the S&P 500 has not hit an all-time high since closing at 2,130.82 on May 21, so the 10-month mark of March 21 is not far away. The bad news: The S&P 500 has fallen only 13% since May 21, and a 35.4% decline from the high would put the S&P 500 at 1,377 — down nearly 26% from current levels.

Of course, a case can be made that the S&P 500 understates the amount of damage done to the stock market, partly because heavily weighted growth stocks like Alphabet ($707; GOOGL), Amazon.com ($490; AMZN), Facebook ($101; FB), and Netflix ($88; NFLX) did not peak until December or later.

The average S&P 500 stock, down 10% so far in 2016, is trading 26% below its 52-week high. Some 402 of the 500 stocks in the index have declined so far this year, and 304 have fallen at least 20% from their 52-week high.

Broad-based declines have made valuations more attractive, with the median stocks in the S&P 500, S&P MidCap 400, and S&P SmallCap 600 indexes trading at slight discounts to the 22-year norms of about 18 based on trailing price/earnings ratio.

But bear markets tend to stop when stocks become truly cheap, and history suggests that has not yet happened. The median P/E of the S&P 500 bottomed near 10 in 2009 and near 16 in 2000.


While the Dow Theory sits squarely in the bearish camp, it's possible the S&P 500 and Dow Industrials can avoid an "official" bear market. However, it would be a mistake to conclude downside risk is limited, as a 20% to 30% decline from current levels would not be surprising.

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