This week, major U.S. equity indexes entered a bear market, dropping more than 20% from recent highs. Stock market circuit breakers triggered for the second time this week on Thursday causing a brief halt in trading. However, stocks continued their fall closing down on the day almost 10%, marking the worst single day drop since Black Monday in 1987. The Fed stepped in announcing swift liquidity measures intraday, but that did little to calm markets. This news comes against a backdrop of a couple of weeks of major uncertainty around the coronavirus, the election, and developments in oil.
There is a lot of confusion around what a bear market actually is, and whether or not it will lead to a recession. So, let’s take some time to break this down and answer some of the most commonly asked questions we get around bear markets.
Should I Be Worried About A Recession?
Let’s start by first pointing out that there will always be a recession in the future, and it’s a natural part of the business cycle. Knowing if we are entering one or already in one is only certain in hindsight. The reality is that by the time we know we are in a recession, the stock market has typically already priced in a large part of the move, and you can usually expect it to do the same on the way up. This means the market almost always starts rebounding well before the skies clear, so timing these things is a fool’s errand. You may get lucky and sell stock before a larger down move, but you now take the risk of not getting back in, a risk that is very real in times of extreme market volatility. Even if you do get back in on time, you probably only end up saving yourself a few percent which is probably not worth the risk you are taking and the stress of making two very hard calls.
Bear markets are often accompanied by recessions, but not always, since the stock market and the economy (although related) are two different things. The market is forward looking and tends to overshoot both to the upside and the downside. Right now, the market is pricing in high odds that a recession will follow, and that’s higher than what the odds of a recession appear to be based on consensus estimates. It’s fair to assume the odds of a recession are higher now that we are in a bear market because they often coincide, but that assumption won’t give you any insight that will help you time the market.
So, it’s best to focus on what matters most and what gives you the best chance of success rather than worrying about what you can’t control. Focus on your long-term goals and what’s needed to get you there, although that can be easier said than done. As it relates to your portfolio, this means making sure you are in the appropriate allocation that aligns with your time horizon, risk tolerance, and financial goals so that you can stick with your long-term plan. That way you can ride out the volatility and not react emotionally during extreme events which tends to lead to poor financial outcomes.
Correction vs. Bear Market vs. Recession
As a refresher, a bear market is – a decline of 20% or more in stock prices usually over a sustained period of time (typically two months or more, but there is no hard number). What’s crazy about this bear market is that it is the fastest bear market in history. It only took 20 trading days to go from a market high to a 20% drop. For some perspective, past 20% drops from market highs took around 8 months or so…
A correction, on the other hand, is a shorter-term market downturn, usually over a timeframe of less than two months It is a drop of less than 20% in major stock indices.
Although U.S. stocks are in bear market territory, this is not the same thing as an economic recession. To clarify, an economic recession is typically defined as two consecutive quarters of declines in quarterly real (inflation adjusted) gross domestic product (GDP). It’s also important to note that even if we do enter a recession, that doesn’t mean that we’ll necessarily experience a full 2008-like economic meltdown. The coronavirus emerged as a black swan event (meaning it was unexpected with potential major impact) against a backdrop of strong economic data in the U.S., which makes this different from the last couple of recessions. So while it’s possible that the current situation might lead to a recession, the impact and length of is impossible to predict.
So, Can a Bear Market Happen Without a Recession?
Contrary to what some people believe, a bear market can actually occur without an economic recession — they are not synonymous. A bear market without a recession tends to be shallower in nature compared to a bear with a recession, which tends to be more severe. Per LPL Research and FactSet, the average drop in all bear markets going back to 1946 was 31%, bears with a recession were 37% and bears without a recession were 24%. And interestingly, according to their data, there was a 50/50 split in bear market instances since 1946 — seven bears without a recession and seven with a recession, out of the fourteen defined bear markets over this period.
5 Ways to Stay in Control of Your Finances During a Bear Market
Both bear markets and economic recessions are natural parts of market cycles and are very hard to predict, so the best thing to do as an investor is focus on what you can control and not get caught up in the sensationalism. Here are some things you can do to stay in control of your finances during both up and down periods in the market:
1. Check your asset allocation and risk tolerance.
Are they appropriate for you? Have the last couple of weeks made you rethink your level of risk? Personal Capital’s free Investment Checkup tool will allow you to assess your asset allocation, and the tool will suggest a target allocation for you based on your financial goals. It’s extremely important to understand what risk tolerance actually is though, because people often conflate risk tolerance with their feelings about current market conditions. Risk tolerance is stable over time and shouldn’t fluctuate based on what the market does. For new investors, sometimes it does take a bear market to realize the amount of risk they can endure for a potential gain.
2. Diversify and rebalance if necessary and at the right time.
Rebalancing your strategic asset allocation during volatility like this can help you systematically buy low and sell high. Bear markets are where diversification shows its true value. Often, the benefits of diversification can be forgotten when markets are going straight up. If you’re not properly diversified, talk to your financial advisor about the best way to get there. Diversification is a key principle in the portfolios we build for clients not just on the asset class level, but also within asset classes. Learn more about our proprietary SmartWeighting methodology here.
3. Get a fiduciary partner.
During emotional times like these when we’re seeing red in our portfolios, it’s important to have a financial partner who can help you through the scary times and provide you with objective financial advice. Ensuring that your advisor is a fiduciary means that they are obligated to act in your best interest.
4. If you are able to and have decades before you retire, consider using this as an opportunity to increase your 401K contributions.
Of course we don’t know if markets will continue to go down in the near term, but it gives you the opportunity to buy stocks at much lower prices than just a few weeks ago.
5. Try not to panic – and keep things in perspective.
Ups and downs are a natural part of market cycles, as are bear markets. But over the long run, investing in the stock market will richly reward investors.