INSIGHTS

On February 29, 2016

AAM Viewpoints - Whether a Correction or a Bear, There is Light at the End of the Tunnel

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A lot has been made of the recent volatility in domestic equity markets and whether we are experiencing a garden-variety correction or a more severe and prolonged bear market. For our purposes, we will define a correction as a loss of greater than 10% and a bear market as a loss of greater than 20%. The S&P 500 Index hit its all-time high of 2,130 on May 21, 2015 and hit a near-term low of 1,829 on February 11, 2016 – a 14.13% drop. While this is clearly in correction territory, a growing number of segments have come much closer to – or have even breached – the 20% mark, including small and mid-caps, dividend payers, numerous international markets, sectors with commodity exposure, and the healthcare and financials sectors, to name a few. This makes the question of a full-blown bear market more genuine. Many investors with exposure to these hard hit areas aren’t asking the question of if this is a bear market, but rather “When will this – whatever this is – stop?”

When measured against corrections for the current bull market cycle, this downtrend is easily the longest in duration. AAM Viewpoints noted last week (Acrimonious Acronyms: Feeding the Fear by Matt Lloyd) that the current selloff is three times longer than the steepest correction we have seen since 2009 (there have been three.) When compared to full blown bear markets, clearly we aren’t there yet in terms of length or severity; however, some historical data aims to put those into perspective as well. We have identified 10 periods when the S&P 500 Index approached a 20% loss since 1960. The following are based on these periods…

Source: AAM

I would like to take the data one step further and differentiate between a bear market that coincides with an economic recession (recessionary bears) and a bear market that occurs outside of an economic recession (non-recessionary bears). While the majority of the time a recession and a bear market in equities overlap, it is not always the case. Since 1960, there have been 10 bear markets, yet there have been six economic recessions during those times, leaving four bear markets that took place outside of a recession. As you might suspect, non-recessionary bears are considerably shorter and less severe than their recessionary counterparts as laid out in the table below.





Source: AAM                                                 

How is any of this good news? Our thesis is that the U.S. economy will avoid a recession. Without a recession there will not be a prolonged bear market, in our opinion. If we are currently in a bear market, and May 2015 was the high point on the S&P 500 which marks the beginning of the current downturn, we would be over nine months in – well beyond the seven-month median (0.60 years) for a non-recessionary bear. Furthermore, the median forward 18 month and 24 month total return for the S&P 500 from the midpoint of a non-recessionary bear market is 1.24%, and 10.50%, respectively. In other words, historical data would imply we are likely over halfway through the current downtrend and we could reasonably expect an average annualized return of 5.25% over the next two years. Of course this assumes two things: GDP remains positive and we officially enter bear market territory for the S&P 500. First, 2015’s 4^th quarter GDP growth was revised higher to 1.0% (quarter over quarter) on Friday with estimates compiled by Bloomberg calling for 2.0% growth in the 1^st quarter of 2016. Second, the S&P 500 has rebounded over 7% from the February 11, 2016 low and now sits about 8% off the high water mark set back in May 2015. If the markets remain in correction territory, the two-year outlook becomes relatively conservative, but could still serve as a roadmap going forward as the volatility that has defined the start of 2016 persists and provide a possible light at the end of the tunnel for investors who aren’t asking “What?” but rather “When?”

CRN:  2016-0201-5144R

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