This October continues to be reminiscent of many bygone Octobers, replete with hair-raising equity market volatility.
The current decline has been triggered by macro factors and certain weak earnings reports mixed with other, stronger ones from U.S. reporting companies. The macro issues have been well known, but the market finally paid attention to them: weakening economic activity overseas (as seen by Purchasing Managers' Index figures that are declining but still indicate economic expansion), the slowing of estimated growth rates in U.S. corporate earnings (i.e., in the neighborhood of +10% in 2019 versus +20% in 2018), tariffs, Federal Reserve interest rate tightening, stock market and currency weakness overseas, increasing corporate leverage and midterm elections. Some companies reporting earnings (e.g., 3M and PPG) have illustrated some economic weakness in the U.S. And the poor stock performance of certain cyclical sectors in the market (energy, materials and industrials) has laid bare fears of recession.
Nevertheless, the difference in what we are experiencing now and whether it is a brief correction or the beginning of a longer-lasting slump will reveal itself over the next several months. And historical perspective can help in these instances to calm the nerves and help investors make rational decisions based on non-emotional factors such as the persistence of economic data—or lack thereof.
Correction or Bear Market?
Not all significant market declines indicate the start of a bear market. More frequently, the market has experienced a correction—a meaningful decline (of between 10% and 20%) that nevertheless does not reach the level of a bear market. Markets have tended to recover from corrections much faster than from bear markets—on average, in about six months since the 1970s.1 Moreover, corrections can provide attractive buying opportunities, while bear markets may warrant a more defensive tactical tilt to a portfolio.
So how is an investor to know, when the market starts declining, whether we are experiencing a correction or the start of a bear market, and what the right course of action is?
The bad news is that it’s not possible to know right away which regime has set in. Corrections and bear markets typically look very similar for the first 13 weeks of a downturn (see display). It’s only after that initial period that they begin diverging, with the market either recovering from a correction or trending further downward.
The good news, however, is that bear markets have tended to move fairly slowly. After the initial 13-week period, the median bear market over the past 50 years has traded flat for around five months before declining again. It’s possible that, by the time a correction sets in, the worst may already be over—and that a recovery is imminent. It’s also possible that the correction is just the start of a prolonged bear market.
For our part, we see a number of constructive signs in the current environment, including stronger-than-expected, just-reported third-quarter GDP growth and some areas of positive earnings surprises, suggesting in our view that the current economic expansion could have some period to run.
However, in the event of a downturn materializing, history suggests that there has often been time to analyze underlying fundamental economic data–and react accordingly.
For more on the characteristics of past market declines, read Preparing for the Next Market Downturn.
A Market Downturn Tends to Reveal Its Nature After 13 Weeks
Path of Median Correction vs. Median Bear Market (1971-2018)
Source: Bloomberg, Neuberger Berman. Based on weekly price return data for the S&P 500 index. Corrections are defined as market downturns of between 10% and 20% (4/1971, 11/1974, 6/1975, 12/1976, 7/1977, 9/1978, 2/1980, 10/1983, 7/1998, 7/1999, 11/2002, 4/2010, 4/2011, 7/2015, 1/2018). Bear market data is for the markets starting in 1/1973, 11/1980, 8/1987, 7/1990, 3/2000, 10/2007. For illustrative purposes only. Nothing herein constitutes a prediction or projection of future events or future market or economic behavior. The duration and characteristics of past market/economic cycles and market behavior, including any bull/bear markets, is no indication of the duration and characteristics of any current or future market/economic cycles or behavior. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed or any historical results. Investing entails risks, including possible loss of principal. Past performance is not indicative of future results.