February 27, 2024

Fundamentally: Tracking a Possible Bear Market

AFTER a week in which stocks sank more than 6 percent, the sell-off in equities that began five months ago is coming perilously close to bear market territory.

Whether this correction turns into a full-fledged bear, and whether the economic slowdown that started the selling in late April is labeled a recession may not matter much in the end.

While it’s true that the Standard Poor’s 500-stock index isn’t technically in a bear market now — at the end of the week, domestic equities were off 16 percent from their April 29 peak — plenty of other parts of the market have dropped more than 20 percent, the requisite mark of a bear.

Small-company stocks in the Russell 2000 index, for example, fell as much as 25 percent earlier this year. Foreign stocks in the Morgan Stanley Capital International EAFE index lost as much as 26 percent. And the MSCI emerging-markets index was down around 27 percent from this spring.

Four of the 10 sectors that make up the S. P. 500, meanwhile, have also slipped into a bear market.

As for broad domestic equities, they’ve taken investors on a very rough ride since the financial crisis of 2008 and early 2009. “This is about as severe as it gets without it being called a bear market,” said Sam Stovall, chief investment strategist at S. P. Equity Research.

In fact, if this slide stops short of the 20 percent mark, it will have been the most severe correction for the S. P. 500 in recent memory that didn’t morph into an official bear market.

This slide feels so much like a bear because of its speed, some market strategists say. Technically, the correction began on April 29, when the S. P. peaked at 1,363.61. But the bulk of the 16 percent decline took place in two brief but volatile periods. First, from July 25 to Aug. 8, stocks fell about 16 percent. After rebounding, they sank more than 6 percent last week.

These free falls would make “even rational, seasoned investors feel like they’ve been raked over the emotional coals,” said James B. Stack, editor of the InvesTech Market Analyst newsletter.

Mr. Stack added that investors weren’t given much warning to brace themselves for the sell-off. In 2008, when stocks swooned amid the collapse of Lehman Brothers, equities had already been in a bear market for nearly a year. This time, the plunge during that short summer window came after stocks rose by more than 21 percent in the previous 12 months.

The market’s day-to-day rockiness is also contributing to Wall Street’s bearish sentiment.

Based on one traditional gauge of volatility — the number of trading days when stock prices move up or down by 2 percent or more — the market today is nowhere near as shaky as it was in 2008 or 2009.

But Mr. Stack used another method to measure the market’s volatility: the spread between intraday highs and lows for stocks. Based on that gauge, he said, stocks have actually been about 10 percent more volatile recently than in 2009.

So does he think that a bear market is inevitable? No.

“I don’t think it’s in the cards,” he said.

Other strategists disagree.

Doug Ramsey, director of research at the Leuthold Group, said in a recent report that he believed that the August swoon represented “the second leg of a new bear market that began after the S. P. 500 and most global indexes topped on either April 29 or May 2.”

One sign, Mr. Ramsey said, is the length of the rally that preceded this sell-off. He looked at all major corrections in the S. P. 500 since 1950 that stopped just shy of a bear market. He found that the median length of the bull markets leading up to those downturns was 50 weeks.

By comparison, the bull that preceded this sell-off was 112 weeks old. The rally, he wrote, may be “too old for the current decline to be only a correction.” And here is one other bearish indicator: Historically, about 80 percent of corrections that took stock prices down by at least 15 percent eventually graduated into official bear markets.

So let’s assume for a moment that the correction does morph into a bear. Would it matter whether it were accompanied by an official economic recession?

Mr. Ramsey looked into that topic as well. Using the Dow Jones industrial average as a proxy for domestic stocks, he separated recessionary bear markets from major declines that were not accompanied by a contracting economy.

Since 1945, stock prices fell by around 30 percent during bear markets that included recessions, versus a 27 percent decline for bears when no recession occurred.

The one big difference, though, was the duration of the market downturns. While bear markets in nonrecessionary environments have historically lasted six months, on average, major sell-offs that took place just before or during a recession have lasted roughly a year longer.

For nearly everyone, investors included, recessions are painful. That’s another reason to hope the economic downturn doesn’t morph into one.

Paul J. Lim is a senior editor at Money magazine. E-mail: fund@nytimes.com

Article source: http://feeds.nytimes.com/click.phdo?i=99e0d0ca020c7bda3c1932c358d873cd

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