If you think a bear market cannot happen while the US economy is growing, think again.
It would certainly be nice if economic growth offered reliable protection from bear markets. For example, the Conference Board predicts that real US GDP growth will be 6.6% for the entire 2021 calendar. Bank of America is forecasting a growth rate of 6.5%. Both estimates are more than double the annualized average growth rate of 2.7% over the past 50 years.
The opportunity to rid you of any wishful thinking about bear markets and economic growth is the recent statement by the National Bureau of Economic Research that the pandemic-induced recession ended 15 months ago. Since the Wall Street bear market ended almost at the same time, it is to be excused that the two are highly correlated.
But you would be wrong for two reasons. The first is that the stock market is expecting several months of recession. That means that when a bear market starts, the economy is almost still growing. This is illustrated in the graph below, which shows bear market lead times for US recessions since 1950. On average, the respective bear markets started 7.2 months before the recessions.
The same goes for the end of the recession – as you can also see from the graph. Although the lead times for ending a recession are shorter than when it started, the average is still 3.6 months. This means that new bull markets are starting while the economy itself is still shrinking.
Either way, you will learn little about the main trend in the stock market, whether the economy is expanding or shrinking by accident. In other words, the stock market is forward-looking and anticipates what’s coming in the market. What is happening has long since been baked into the share price.
The second reason you might mistakenly think that a bear market cannot occur when the economy is growing is that some bear markets are not accompanied by a recession. In fact, this has been the case on nine separate occasions since 1950, according to a bear market calendar maintained by Ned Davis Research.
This is the source of the late Nobel Prize winner Paul Samuelson’s famous joke that the stock market predicted nine of the last five recessions. But his joke isn’t entirely fair; it assumes that the only reason for a bear market is economic weakness, which it is not.
Another possible cause of a bear market is that stocks are sometimes too far ahead of fundamentals. In such cases, the economy could continue to grow even if stock valuations rise again. This is especially important right now as the stock market is either more or almost overvalued than it has ever been in US history.
Another possible cause of a bear market as the economy continues to grow: an exogenous event that does not have a far-reaching economic impact. One example of this was the bankruptcy of Long Term Capital Management in the summer of 1998, which resulted in the S&P 500 SPX falling + 0.17% 21% on an intraday basis over a six week period.
Regardless, the investment implication is clear: a bear market could begin at any time, regardless of how strong the economy appears to be.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert ratings track investment newsletters that pay a flat fee for testing. He can be reached at [email protected]
Also read: Here is another sign that the bull market is nearing a high point and it needs to be watched
Plus: Why many stock investors worry when this market indicator gets as high as it does now