Following the steep market selloff last year, market pundits caused hysteria by prematurely declaring the beginning of a bear market. How does that impact the market and what can investors learn from the market and the media?
The steep stock market selloff at the end of 2018 was a stark reminder to investors that what goes up will come down. After ten years of a relentless climb with few significant selloffs, the bull market has been showing its age with increasing volatility. Many market pundits, who have long been predicting an imminent bear market, watched with bated breath as the market zigged and zagged in and out of correction territory over the last year. When the market made its swan dive in the final three months of the year, many pundits were quick to pounce on the inevitability of a bear market, with some making the call that the market had indeed crossed into bear territory.
But, did it? And, what are the consequences when the financial media jumps the gun and unleashes unwarranted hysteria among skittish investors? Is there any difference in characterizing the selloff as a bear market or a market correction, and what does it mean to investors? Was it a bear market or not, and what can investors learn from the market and the media?
The Media Misdiagnoses the 2018 Bear Market
These are the questions investors should be asking as a result of a report issued by global media outlet, CNBC, proclaiming the start of a new bear market. However, as modern definitions go, the market stopped short of reaching bear market status, which occurs when it falls 20% or more from its recent peak. From its peak on September 20 to December 24th, when CNBC made its emphatic announcement, the S&P 500 index had fallen 19.78% — technically just shy of bear market territory.
If we adhere to the modern, technical definition of a bear market, then CNBC got it wrong. If they would have called it a “correction,” they would have gotten it right, except that the stock market reached the correction milestone two months earlier after it had fallen more than 10% from its September 20 peak. So, what’s the big deal? Shouldn’t investors be concerned with either a bear market or a correction?
Why It’s a Big Deal
Both corrections and bear markets occur with some regularity. In fact, since 1945, there have been 22 corrections, not including the most recent one, and 12 bear markets for a total of 35 major downturns. Bear markets start out as market corrections, which means less than 40% of market corrections have turned into a bear market. By definition, bear markets are more severe than corrections. Two of the more recent bear markets that started in 2000 and 2007 resulted in 50% declines that last around 18 months. By contrast, corrections result in 10 to 20% percent declines over a much shorter period – an average of 5 months – before the market starts to recover.
Understanding the distinction, do investors react differently to bear markets and corrections? Investors with a long-term investment horizon tend to accept periodic market corrections as a cost of investing. Because they are less severe and generally short-lived, it’s easier to stay focused on the long-term and ride out the storm. However, because bear markets can last much longer and there’s no telling where the bottom is, even disciplined investors can get caught up in the panic of the herd.
Therein lies the danger of attaching the bear market label prematurely. The label itself has the potential of setting off a narrative that, on its own, can trigger a much steeper market decline. Even the speculation of an impending bear market can be intensely disruptive, enough to fuel the self-perpetuating fear and confusion that can drive the herd over the cliff.
Stock Market Narratives Matter
In the stock market, narratives matter. Whether propelled by the exuberance of a historic bull market or leveled by the crushing despair of a bear market, investor emotions can drive the market beyond the bounds of rationality. In December, CNBC, generally an influential and trusted financial media outlet, created a false narrative that could have led investors to take actions harmful to their portfolios. It’s likely that many investors fled the market in panic and are now waiting for the bottom of a bear market that has yet to come. In the meantime, through March 22 of 2019, the stock market has recovered more than 80% of its losses.
We often tell our clients that the only concern they should have about a bear market is how they react to it. While we can’t predict when it will occur, we know that it will. However, investors need to keep in mind that every bear market eventually gives way to a longer lasting bull market. And, despite the 12 bear markets that have occurred since WWII, the stock market has still advanced nearly 200-fold. In that perspective, bear markets are nothing more than a temporary interruption of a longer-term uptrend.
Always Stay Focused on the Long-Term
With that insight, long-term investors should refrain from making major changes to their investment portfolio simply because the market fluctuates by 10 or 20%. As with any significant economic or market event, you should use this information along with other data to rationally reflect on your investment strategy and whether it is still appropriate for your long-term investment profile.
More importantly, you should exercise caution when the media begins to spew alarmist opinions and reporting. What the media won’t tell you is that a steep drop in the market, or some other major economic event, while seemingly consequential at the moment, will have very little impact on the long-term returns of a properly constructed investment portfolio 20 or 30 years in the future.
