Yesterday I was having a conversation with a colleague that spanned a wide range of topics from investment research sources to best business practices.
During the course of our dialogue the concept of recessions and bear markets came up and it sparked a question that I think many people are asking themselves:
Can we have a typical bear market in the U.S. without the sobering reality of a full blown recession?
My answer is yes and let me tell you why.
For starters, the most common definition of a bear market in stock is a 20% drop in the major indices from their highs. Additionally, a recession is defined as back to back quarters of negative economic growth as measured by Gross Domestic Product (GDP). Many will dispute those arbitrary analytics, but they are still considered by a vast majority to be the overriding measures of these occurrences.
During this conversation, I brought up the example of 2011, when the S&P 500 Index fell by 19.38% from high to low on a closing basis. Many don’t consider this to be a bear market although it literally just missed the mark by a handful of basis points. If you actually took the intra-day highs and lows, it would have made the cut off.
We can debate for days what caused the 2011 sell off and subsequent recovery, but the overriding truth is that the event was over in a matter of three or four months. It started with a big August drop, a small recovery, a retest of the lows, and then on to new highs. Over and done with in a relatively short period of time.
Now when we turn to the chart of the quarterly change in GDP, it’s easy to see that productivity remained above the flat line throughout that event. No calls for a recession or other black mark on the overall health of the economy.
In my opinion, this example shows that we can have a very fast down swing in the market that is accompanied by a swift recovery without the fear of a recessionary environment. Could the 2016 market fall 20, 25, or even 30% and then rocket back to safety in a matter of months? Absolutely. I’m not saying that is going to happen, but we can’t rule it out either.
From high to low, the S&P 500 Index fell 15% on an intra-day basis at the February 2016 trough. This certainly represented a very pernicious decline, but only about ¾ of the way to a full blown bear market. Of course, many already consider the market to be in a state of bearish discontent because the average stock has declined more than 20% from its highs. The only reason the S&P 500 hasn’t is because of its market-cap weighted structure that is lending size to a few strong stocks in the bunch.
I think that in today’s market, fears of a recession have been heightened by the hangover from the 2008 financial crisis that has yet to be purged from our collective memory. Those scars may never leave the generation that experienced the awful declines in housing prices, rising unemployment, and unprecedented stress in the financial system.
Nevertheless, you can’t let fear guide your investment decisions.
There are a number of ways to mitigate the risk of a bear market in your portfolio or tone down asset allocation and still achieve your financial goals. You don’t have to sit on the slide lines and lament the Fed or the banks or the government for their errors. In fact, that is probably the worst thing you can do with your money as it ensures your capital will never grow to reach your goals.
There is nothing wrong with taking a cautious approach at this juncture with all the volatility that has been unleashed on stocks over the last several months.
However, you should also view these sell-offs as opportunities to evaluate your current positioning and make sensible changes as needed to take advantage of new opportunities.
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