“All good things must come to an end”, “What goes up, must come down” – a bear market is the stock market’s answer to investors’ dreams of everlasting asset growth. But how long does it take to recover after the market hits rock bottom?
A bear market is defined as a peak-to-trough fall in the value of assets (a “drawdown”) of 20% or more. Since the end of WWII there have been eleven bear markets recorded on S&P 500, the US stock market, on average occurring after every 5.3 years of growth.
The 11 years from the lows of the 2008 Global Financial Crisis (GFC) crash, to the all-time highs before the COVID-19 pandemic hit, was the longest period of continuous stock market growth since WWII.
So, if we have a long-term investment time horizon, it is safe to assume that there will be a few significant setbacks along the way. To determine the extent to which a 20%+ drawdown will stunt the growth of a pool of equity investments, we look below at the statistics on bear market duration, severity and recovery.
Table 1: Market cycles – a summary of market cycles since WWII ranked on size, in terms of bear market, followed by a recovery, followed by a further period of growth before the next bear market.
- Graph 1 above shows the relationship between the bear market duration (the amount of time the market was in a downtrend) and the recovery period (time to get back to pre-bear market levels). The amount of time a market is trending down and the amount of time to recover do not seem to be strongly correlated.
- Graph 2 shows there is a similar lack of relationship between the length of a bear market and its severity. A long period of falling assets does not necessarily mean they fell by a large amount, and vice versa. In other words, historically, the bear market duration has not had a significant effect on the other characteristics of a bear market.
- However, Graph 3, plotting the relationship between the severity of a bear market and the recovery time, shows a more distinct trend; the size of a bear market is correlated to the amount of time to recovery. Even when you look pre-WWII at the stock market crash of 1929, the precursor to the great depression, the trend holds. The 83% decline in the S&P 500 took 151 months (nearly 13 years) to recover from.
So, when looking at historic bear market recovery periods, a pretty good indicator has been the size of the mountain to climb to get back to previous levels. A “snap recovery” is possible for minor drawdowns, the 3-month recovery from a 27% drawdown in 1980 is the best evidence of this. However, larger bear markets are associated with deeper problems in financial markets, and can take significantly longer from which to recover.
In an ideal world, an investor would enter the market at the start of a bull market, remain invested until just before the start of a bear market, disinvest into bonds or cash until all the damage has been done and then reinvest. This is of course impossible to do. However, many investors often do the opposite – when the markets have been going up for a while they invest, and when markets fall, they lose confidence and disinvest, missing out on gains and locking in losses.
Trustees should keep this in mind in times such as these, where the S&P 500 fell 34% from 19 February to 23 March 2020. History would suggest that this level of losses takes between one and two years to claw back. This certainly feels like a long time to go without making progress towards goals, however, panicking and disinvesting now would mean missing out on the recovery and extending the amount of time until goals are reached.
As the conditions that caused markets to decline start to stabilise, so will investor confidence. Investors will stop seeing the stock market as a risk not worth taking, and start to see the value that presents itself after a significant market correction. Confidence will slowly creep back as the recovery gets going and, after a while, those that withdrew will start to return. Positive sentiment will snowball and the market will revert back to reasonable levels. Inevitably, when positive sentiment eventually reaches excess levels, the market will correct itself once again and hence the market cycle continues.
Even accounting for the inevitable bear markets, investing assets in the stock market is still a good way to protect against inflation and grow assets over time. While remaining invested is easy as the gains come in, doing so when they are not is hard, but just as important.