How Long Will the Bear Market Last?

As markets continue to crash, investors are panicking. However, this is not anything new. A month ago, it seemed as if Covid-19 would be halted in China. However, the virus has proven to be too contagious to contain, and a few European countries, including Italy, are in lockdown in a bid to prevent it from spreading.

In the United States, things are looking no better. Many subject matter experts believe that the U.S. will be left with no option but to follow the lead from China and Italy and restrict travel activities for a certain period of time. On Sunday, the Federal Open Market Committee decided to cut rates to zero, but this didn’t help the market performance on Monday either. In fact, the Dow dropped more than 2,900 points, or almost 13%. With this plunge, the Index is now down 31% off the highs reported last month. In every sense, this means that U.S. stock markets are in bear territory.

Source: Bloomberg

The question that many investors want an answer for is how long this bear market can last. In this analysis, I will attempt to determine an answer based on historical data and current developments.

Historical market crashes and their duration

The data presented in this segment of the analysis may not be encouraging for many investors. However, it’s important to grasp reality as it is and be prepared for the worst. This way, further losses can be avoided, and more importantly, time can be allocated to finding the best opportunities.

Data compiled by Path Financial Limited going back to 1956 reveals that a bear market lasts a median of 645 days.

Source: Path Financial

Going by this data, it might take around two years for the markets to report a new high. However, this doesn’t reflect the true nature of the current market. Historically, it has taken a median of 307 days for the S&P 500 Index to fall more than 20% from a recent high. However, it has only taken 22 days this time around. This is a clear indication of the velocity of the current market decline. Therefore, it’s reasonable to believe that the market might return to its normal state faster than what empirical evidence suggests, once the reasons that led to the crash cease to exist. In this case, it’s panic over the spreading of Covid-19.

A recession leading to a severe decline in stock prices is one thing, but a pandemic doing the same is another thing. This is because a pandemic, however severe it is, will likely be short-lived. This increases the chances of recovery sooner than many investors are factoring in.

According to data from the World Health Organization, the number of reported Covid-19 cases in China increased from just 300 on Jan. 20 to more than 75,000 on Feb. 20. However, since March 1, the country has reported less than 200 new cases. This may show the effectiveness of quarantine measures.

As reported by the Harvard Business Review on March 15, manufacturing activities are already well and truly on their way to recovery in China, and business activities are resuming slowly. The situation in the United States does not look good at the moment, but if the responsible authorities follow China’s lead, it would be safe to assume that the country will be back to its normal state within 30 days following complete shutdown.

The economic impact of shutting down the economy would be massive. However, a resumption of economic activities will boost the sentiment of investors and will likely lead to surging stock prices, as equity markets are leading indicators of the business health of a country.

Odds of a recession in 2020

Financial media sources often use the word "recession" in a manner that embeds fear in the reader’s mind. Unfortunately, some of the investors do not take the time to understand what this means.

When quarterly GDP growth reports negative numbers in two consecutive periods, a recession has occurred, according to economics theories. Such a phenomenon is associated with rising unemployment levels, a contraction in consumer spending and declining household income.

A line has to be drawn between an economic downturn and a stock market crash. Even though the Dow has plunged more than 30% from its peak within a month, this is not an indication or a confirmation of a recession. However, there is every possibility of one, if the virus cannot be contained within the next few weeks. A nation-wide shutdown will affect the industrial sector dramatically, and many retail stores will also be affected. Only some companies may be in a better position to tackle a lockdown if they are able to implement work-from-home policies.

In January, the Bloomberg economic recession prediction model indicated a 25% chance of a downturn within the next 12 months. Since then, however, the odds of a recession have climbed to above 50%.

Source: Bloomberg

Whether or not the U.S. will see a collapse in business activities that extend beyond two quarters will depend on the country’s ability to prevent the virus from spreading. Data from China, South Korea and Singapore give hope that the U.S. would be able to follow the same path as these nations and eliminate the threat within a month. Therefore, despite the common belief, Covid-19 may not push the economy to recession.

The below table, which lists every recession since 1900, can be used as a guide to gauge a measure of how long the downturn might last, if the U.S. hits recession territory:

Source: Bloomberg

Many economic growth contractions have lasted less than a year, and if the U.S. enters a recession in 2020 due to the impact of Covid-19, chances are that this will most likely last only a few months. This is because of the short-lived nature of the economic impacts of this virus outbreak.

IHS Markit chief U.S. economist told MarketWatch, “We now expect a recession to begin in the second quarter that will likely last through the end of this year.” Investors need not panic about this worst-case scenario as well, because recovery is within sight.

Takeaway: treat this as a market event and focus on company fundamentals

Predicting whether an economic growth decline is on the cards with any degree of precision is not practical due to the large number of variables at play. Allocating time and money to do this would most likely prove a futile task. There’s reason to believe that America will not be in a recession this year, and even if the country enters one, a very high probability of a recovery exists within six months. The same is true for the bear market as well. There’s no way to predict when the market would recover, but it will, as it has done on many occasions throughout history. It’s reasonable to believe that stock prices will soar once the business activities resume.

For investors, the best course of action would be to analyze company fundamentals, outlooks and valuation multiples to determine whether a stock is undervalued. Without paying too much attention to the external developments, investing in value bets could lead to stellar returns in the future.

Disclosure: I do not own any stocks mentioned in this article.

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