Financial markets have been characterised by extreme levels of volatility over recent years, and the first half of 2022 has proved to be no different. A combination of monetary policy tightening, high levels of inflation in developed markets, and the Russia/Ukraine war have presented significant headwinds to asset prices. Steep declines in the S&P500 and NASDAQ100 have followed with both being respectively down 21% and 30% year to date. Accordingly, investors are bracing themselves for what could be a protracted bear market.
The nature of the beast
A bear market is considered to have begun when an asset’s price has fallen more than 20% from its recent high. This need not only refer to equities but can also include (inter alia) commodities, forex, crypto or even real estate. Bear markets are characterised by periods of extreme investor pessimism and low confidence. The bear is symbolically derived from the fact that a bear swipes downwards when it attacks. No bear market is the same and the trough of a bear market may not be apparent until well after it has passed. Pandemics, wars, economic shocks, and natural disasters are amongst many events that can poke the bear.
| Peak | Trough | Duration (months) | Decline | Event(s) |
|---|---|---|---|---|
| Sep-1929 | Jun-1932 | 33 | 86% | Crash of 1929, 1st part of Great Depression |
| Mar-1937 | Apr-1942 | 62 | 60% | 2nd part of Great Depression, WWII |
| Oct-2007 | Mar-2009 | 17 | 57% | GFC |
| Jun-1911 | Dec-1920 | 116 | 51% | WWI, Post-war auto bubble burst |
| Mar-2000 | Oct-2002 | 31 | 49% | Dot-com bubble burst |
| Jan-1973 | Oct-1974 | 21 | 48% | Inflationary bear market, Vietnam, Watergate |
| Nov-1968 | May-1970 | 18 | 36% | Start of inflationary bear market |
| Jan-1906 | Oct-1907 | 21 | 34% | Panic of 1907 |
| Feb-2020 | Mar-2020 | 1 | 34% | COVID-19 crash of 2020 |
| Aug-1987 | Oct-1987 | 2 | 33% | Black Monday |
| Mar-1946 | Jun-1949 | 40 | 30% | Post-war bear market |
| Dec-1961 | Jun-1962 | 6 | 28% | Height of Cold War, Cuban Missile Crisis |
| Apr-1903 | Sep-1903 | 5 | 22% | Rich Man's Panic |
| Sep-1909 | Jul-1910 | 10 | 21% | Enforcement of the Sherman Anti-Trust Act |
Four stages of a bear market
There are four distinct stages that a bear market is considered to typically undergo:
The initial stage is a period of positive investor sentiment and elevated asset prices. Profit taking will occur and short-term price declines will be ignored by most market participants.
Next is the onset of panic. Price declines are sharp with trading activity dropping. Analyst expectations of earnings will be downgraded, and economic data will begin to be lacklustre.
The longest stage is what follows next when panic selling recedes, and there is a general acceptance that a bear market is in motion. Price declines are far more gradual. Speculators will enter the market leading to bear market rallies which will be short lived.
Lastly, when prices look to have levelled off and good news starts filtering through, asset prices begin to rise. The bear market comes to an end and a new bull market begins.
Purely a part of the process
While uncomfortable to live through, bear markets are a natural part of investing. The good news is that they are usually much shorter in duration than their bull market counterparts. Bank of America data shows that US bear markets have lasted ten months on average with an average peak to trough decline of 38%. On the other hand, US bull markets have lasted 64 months on average and returned 200%.
Bulls make money, Bears make money too
Investing through a bear market can be unnerving even for the most sophisticated investor. It might be tempting to think about waiting out the bear market, in the hopes of jumping back in when the bull market resumes. This approach sounds optimal on paper but the thing with a bull market (like a bear market) is it can only be recognised in retrospect. Trying to time the bull market could easily result in missing out on a lot of the upside.
A well-diversified portfolio allows investors to protect capital in times of bear markets. Within equities, high dividend yielding stocks offer investors the opportunity to be “paid to wait” until prices bottom out. Bear markets also offer the opportunity for investors to own high quality stocks at attractive valuations.
Tools such as short selling and put options offer the opportunity to make gains from price declines. These are instruments which are available to hedge funds. A bi-directional investment strategy offers more ways of protecting assets and delivering positive returns irrespective of market direction. The 36ONE hedge funds have held up well during testing times. Our ability to defend capital extends also to our pure equity mandates, as can be seen by the outperformance of the 36ONE long only funds over time. By protecting capital in bear markets, our funds position themselves to outperform over the long term.