A Closer Look at Bear Markets

The S&P 500 Index is inching closer to bear market territory (a 20% correction based on closing prices). Going back to World War II, we found there have been 14 bear markets, with seven taking place during a recession and seven without an accompanying recession.

As the LPL Chart of the Day shows, the seven bear markets that accompanied a recession were quite painful, losing 37% on average. On the flipside, non-recessionary bears weren’t as painful. Looking at the previous four, three of them ended at 19% corrections (reaching the 20% threshold intraday). While stocks fell 34% in 1987 without an accompanying recession, conditions were quite different than they are now. Remember, the S&P 500 was up more than 40% year to date in August 1987, so a potential violent snapback was likely. “The bottom line is that you can have bear markets without a recession,” explained LPL Senior Market Strategist Ryan Detrick. “But, as we’ve seen over the past 40 years, if the economy is on firm footing, bears tend to stop around a 20% loss and the occurrences of a massive drop are quite limited.”

Not all Bear Markets are Equal

Two Other Important Considerations

Year to date, the S&P 500 is down 7.7%, yet earnings and gross domestic product (GDP) growth have been quite impressive, while stock valuations (price/earnings ratio, or PE) have compressed. We previously saw stocks pause amid a strong economic backdrop with a drop in PEs in 1984 (real GDP 7.3% and earnings 21%) and 1994 (real GDP 4.0% and earnings +19%). Both 1985 (26% S&P 500 returns) and 1995 (35% S&P 500 returns) rebounded with strong S&P 500 returns. Could 2019 continue this trend?

Additionally, the midterm election year historically is the most volatile out of the four-year presidential cycle. In fact, since 1950, the S&P 500 in a midterm year has pulled back an average of 16.9%—the most out of the four-year cycle. The good news? From the closing low in a midterm year, a year later stocks have been higher 17 of the last 17 times. Given the S&P 500 just made a new closing low this week, could this actually be a potentially good signal?

In the end, the largest market corrections take place during recessions. Will we have a recession in 2019? We don’t think so, and as we explained in our recently released Outlook 2019, we believe fiscal policy, business spending, and capital investment will help produce GDP growth of between 2.5-2.75% in 2019.

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. The economic forecasts set forth in this material may not develop as predicted.

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