Three Little Bears

A favorite book in our household is “Goodnight Moon,” written by Margaret Wise Brown. My oldest son, who is now six, has “outgrown” the book, but my youngest son just recently picked it up and asked me to read it again for the first time in a long time. One of the pages reads, “there were three little bears, sitting in chairs,” and it reminded me of a Goldman Sachs research paper I recently read. (#quarantinereads) The Goldman Sachs paper crystallized something I’ve said many times, but does so in a data-driven way–this bear market is different than 2008 and 2002, and that could be a good thing.

We’ve all heard the standard disclaimer that past results do not indicate future outcomes (or something along those lines), but the past can help us put the present into perspective. The Goldman Sachs report, reviewed every bear market – defined as a drop of 20% or more from a previous high – from 1835 to 2009. They took their research one step further and categorized each bear market into three distinct categories–a structural bear market, a cyclical bear market, and an event-driven bear market. Their research indicated 27 bear markets occurred during that time period, of which seven were structural, fifteen were cyclical, and five were event-driven.

Let’s define each bear market and give some characteristics of each:

• Structural Bear Markets typically are the worst markets in every metric. Examples of structural bear markets would be the Great Depression, the tech bubble of 2000, and the financial crisis of 2008.
• Cyclical Bear Markets occur within the normal flow of business cycles. Think of these simply as the “bad years” that all business have had at some point in their life cycle. Signs of a cyclical bear market include rising interest rates and lower corporate profits. The most recent cyclical bear market was in 1990.
• Event-Driven Bear Markets are unforeseen and usually have a sudden onset, which is exactly what our current bear market is being driven by, the unexpected COVID-19 crisis. Historical examples of event-driven bear markets would be various wars or abrupt policy changes.

When Goldman Sachs broke out the data for each of these three bear market categories, there were some interesting differences as outlined below:

• Structural Bear Markets typically last for 42 months, have an average decline of 57%, and take an average of 111 months for recovery.
• Cyclical Bear Markets typically last 27 months, have an average decline of 31%, and take an average of 50 months for recovery.
• Event-Driven Bear Markets typically last nine months, have an average decline of 29% and take an average of 15 months for recovery.

So what does all this data mean and how should we respond? Based upon what we know about the market right now, it would be fair to classify this as an event-driven bear market. Additionally, based upon historical data, event-driven bear markets tend to be the shortest type of bear market. It is true that we have never had an event-driven bear market caused by a virus, but we have also never had a government response to the tune of 2.2 trillion dollars.

Obviously, none of us know the future, and we are certainly not out of the woods by a long shot, both from a healthcare or investment perspective. However, investors should be encouraged by the fact that there have been 27 bear markets since 1835…why? Because the stock market is still here today, despite those bear markets.