Are We In A Bear Market?

Posted by Team HFM on September 01, 2015

The dust seems to be settling after the worldwide equity market setback of the last few trading days.  On Friday the 21st and Monday the 24th S&P 500 fell almost 7.5%, which was the 17th worst 2 day period for the S&P 500 since 1950.  Of the 16 that were worse, 9 occurred during the 2008 bear market, 3 during the tech bubble years and 3 during the 1987 market crash.  Only one occurred independently, an 8.5% pullback in May 1962.  So while this recent fall is not unprecedented, the groupings of previous falls make further analysis of this fall prudent.

Each of the 3 clusters of 2 day market falls had unique circumstances that are not occurring in the current market.  In 1987 interest rates were rising sharply and the S&P 500 was rallying strongly at the same time.  The rate on the 10-year US Treasury bond went from a low of about 7% in January to 10.25% in mid-October, while the stock market was up almost 40%.  Since rising interest rates generally diminish equity valuations, this environment was an accident waiting to happen.

The late 1990’s to 2000 era was the tech market bubble during which equity valuations reached some of the highest levels ever seen.  At those levels, many stocks were trading based on speculation and a correction was warranted to restore more reasonable valuations (a process that took until the Fall of 2002).  Unfortunately most of us can still recall the pain of the 2008 era.  But here too, the market problems were born from a market bubble.  Only this time the bubble was in the residential real estate market which dragged down mortgage-backed bonds and that route pulled down the stock market.

While the conditions from these previous markets do not exist today do we have a bubble of our own?  We do not believe that any of the domestic markets show any signs of being in a bubble.  Certainly, however, the Chinese market had reached unprecedented valuations over the last few months that constituted a bubble.  The correction of that condition has been occurring over the last few weeks as concerns about the declining growth rate of the Chinese economy mount.  Yet it is easy to forget that it was only last year that the Chinese equity market was partially opened to outside investors and while China has a large population, its economy is still not considered to be developed.  Thus while the deflation of their bubble has some effect on U.S. markets, it certainly not comparable to the effects of the 2000 and 2008 bubbles.

Having argued that conditions that caused multiple market drops in the past do not appear on the current landscape; could we be at the beginning of a good old fashioned bear market?  Here too, history would not lead us to believe so.  Most bear markets are associated with economic recessions.  Certainly you could criticize the current economy for its poor growth rate, but it is not shrinking, nor are any of the traditional economic measures such as a decline in the leading economic indicators pointing to a recession.

So what is an investor to do in a market like this?  As unsatisfying as it sounds, historically the best strategy is to do nothing, assuming that your portfolio is fully invested and balanced properly.  While there are breathless news stories about a few investors who have profited handsomely from this market, they are more like lottery winners, rare and unusually lucky.  Having said that, there may be opportunities that have been created recently.  At HFM, we are pouring through the markets looking for those opportunities and we will make adjustments to client portfolios as we see them, in the mean time, we are riding through this one.