A lot of ink has been spilled in the past 24 hours ever since US equity markets and global equity markets have officially entered bear market territory. And with media pundits and talking heads giving their Cassandra-like predictions on national TV, any investor’s resolve is currently being tested to the maximum.
But this begs the question: Do you really need to be worried about the current bear market?
Let’s have a cool-headed look at what previous bear markets have taught us.
Historically, equity returns following sharp market declines have, on average, been positive. A broad market index tracking data since 1926 in the US shows that stocks have tended to deliver positive returns over one-year, three-year, and five-year periods following steep declines. Cumulative returns show this trend to striking effect, as seen in the picture below:
(Fama/French Total US Market Research Index Returns, July 1926-December 2021)
As a quick side note clarifying the picture above, a 10% market decline is officially labeled a “correction” (= left side in the picture above), whereas a full-blown bear market requires a market decline of at least 20% (= the middle columns and the three right most columns depict post-bear-market equity returns over a 1-year, 3-year, and 5-year return).
On average, just one year after a market decline of 10%, stocks rebounded 12.5%, and a year after 20% and 30% declines, the cumulative returns topped 20%. Over three years, stocks bounced back more than 30% from declines of 10% and 20%, although—while still positive—returns were not as impressive after 30% declines. But five years after market declines of 10%, 20%, and 30%, the average cumulative returns all top 50%.
Now, rather than showcasing only the average post-bear-market returns for all bear markets since 1926, how about the picture depicting how a typical 60/40 risk portfolio fared during the worst 7 bear markets during the past 35 years?
The end result is almost identical to the “average post-bear-market equity returns since 1926” discussed at the beginning of this article. As you can see, three years and five years after each event, it is all water under the bridge and in fact, the respective bear market turned out to be a return-boosting portfolio period during which rebalancing or even re-risking pays dividends a couple of years further down the road. Astute readers might wonder why the March 2020 Covid lock-down did not make the cut of the top 7 worst recent bear markets. As you might recall, the speed of market decline in March 2020 was certainly unusual, but the actual decline magnitude did not place the March 2020 market melt-down in the top 7.
In summary, a cool-headed look at the historical data makes a clear case for sticking with a thoroughly laid-out investment plan. Handsome rebounds after steep declines help put investors in a position to capture the long-term benefits equity markets offer to investors. You just need to stick with your investment strategy. Investors will be well advised to muster their inner stoic during turbulent market times as we currently experience.
Sources:
1. Fama/French Total US Market Research Index Returns, July 1926-December 2021 2.mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html
3. Bloomberg, CRSP, Compustat
4. Market declines or downturns are defined as periods in which the cumulative return from a peak is –10%, –20%, or –30% or lower. Returns are calculated for the 1-, 3-, and 5-year look-ahead periods beginning the day after the respective downturn thresholds of –10%, –20%, or –30% are exceeded. The bar chart shows the average returns for the 1-, 3-, and 5-year periods following the 10%, 20%, and 30% thresholds. For the 10% threshold, there are 29 observations for 1-year look-ahead, 28 observations for 3-year look-ahead, and 27 observations for 5-year look-ahead. For the 20% threshold, there are 15 observations for 1-year look-ahead, 14 observations for 3-year look-ahead, and 13 observations for 5-year look-ahead. For the 30% threshold, there are 7 observations for 1-year look-ahead, 6 observations for 3-year look-ahead, and 6 observations for 5-year look-ahead. Peak is a new all-time high prior to a downturn.