Blog Posts — June 29, 2022

A thesis redux: The equity market downturn probably has more to go if history is any guide

by Melissa R. Brown, CFA

Note: This is a re-issue of a blog post we ran the last time the market hit an unusually rough patch, in 2020. Some of the wording has been changed but much remains the same. We have added data on the current US bear market.


Historically, bear markets have been rare. Since 1982 there have been five drawdowns of 20% or more (the ‘official’ bear market definition), including the current one, with a cycle of seven to 13 years in between each one. The present case is unusual, as it has only been two years since the last one.  

As it happens, my experience working in equity markets corresponds almost exactly with the inception of the Axioma US Equity Factor Risk Model in 1982, so I can not only study history but (partially) remember it as well. Although it was not the case in 2020 when central banks went all-out in an attempt to stem the fallout from the Covid crisis, the data and my experience suggest to me that we are likely to have further to go in this downturn, and it could take a long time for the market to retrace its steps back to its January 2022 level.

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Until this year, there had been four official bear markets in the 40 years of the model[1]: 1987, remembered mostly for Black Monday on October 19, but actually starting in August that year; March 2000 through October 2002; October 2007 through March 2009; and January through March 2020.

Figure 1 shows the path of the Axioma All-Cap Market Portfolio from the start of each bear market to the previous high-water mark. I have also included the current market slide (through Wednesday, June 22). Most notable from this chart is that it took months longer than the current market’s six-month drop to reach the sell-off’s bottom in two of the past bear markets (2000 and 2007), but a shorter time in the other two.

Figure 1: US equity bear markets

Source: Qontigo

To paraphrase Tolstoy, every bear market is a bear market in its own way.

1987’s decline started from a wildly overvalued level and it is often blamed on portfolio insurance and relatively nascent program trading. At the time, I was Head of Quantitative Research at Prudential Securities, writing quant commentary. I remember feeling increasingly alarmed at how overvalued the market had become, with an opinion that obviously ran counter to many investors’ views as they drove stocks higher and higher. I believe the market fell so much because it started from such lofty prices, even if the economy did not seem to be in potential trouble. Because there was no real economic issue at the time, at least not that I can remember, the recovery back to the prior peak was relatively swift.

When the Twin Towers fell in 2001, we were already deep in a bear market whose origin laid in the bursting of the internet bubble in early 2000, and it was another year before the market stopped sliding. Although valuations were rich at the internet boom peak, I do not remember the market seeming wildly overvalued by 9/11. Despite the more normal valuation levels, the market took 30 months to bottom out, and four more years to regain all it had lost.

The slide related to the Global Financial Crisis (2007-2009) also began well before investors fully realized what was happening, as mortgage lenders began to fail, followed by other financial institutions. Of course, by this time markets were much more globally integrated (as they are now), and the economic fallout that started in the US was quickly exported. Interestingly, the peak-to-trough period for this bear market was shorter than in the 2000-2002 crisis, but the recovery to the previous high took about the same amount of time.

Obviously, none of the modern-day bear markets prior to the one in 2020 was associated with a sweeping pandemic with global reach and extremely uncertain economic outcomes. The 2020 downturn started with interest rates already so low that there was not very much room for the Fed to maneuver, but maneuver they did, not only in Treasury securities but also by backstopping credit. Combined with fiscal stimulus, the Fed’s actions served to halt the market’s decline and accelerate the recovery. The prior high-water mark was achieved by July 2020, making this downturn extremely short-lived.

Figure 2 shows the path of the US 10-year Treasury bond yield over the course of the bear markets. Rates were much higher at the outset of the 1987, 2000 and 2007 downturns, meaning there was more room for monetary stimulus. Long-term rates fell throughout the course of each one (1987’s rate ended the bear market where it had started). However, the 2020 case demonstrated that there was still potential benefit from an accommodative Fed even with ultra-low rates.

One obvious difference this year from the prior four bear markets is that Treasury yields have risen substantially, in sharp contrast to the previous experiences. While yields made bonds progressively less attractive as an alternative then, at the same time as hints of a recovery started to emerge, bonds were less attractive than equities. So far that is not the case this time around – bonds are becoming increasingly viable alternatives to stocks. In addition, in 2000, 2007 and 2020 the correlation between equity and bond prices was negative, whereas this year it is positive. Diversification ability has suffered as correlations have increased (See our recent risk monitor commentary on this topic.).

Figure 2: US benchmark yields

Source: Qontigo

I said this in 2020 and was wrong, but once again I suspect the stock market recovery is much more likely to be long and drawn-out like it was in the 2000 and 2007 instances. With inflation remaining much higher than it has been for 40 years (therefore higher than it was for any of the aforementioned bear markets), the Fed is threading a difficult needle between lowering inflation and managing a recession. With the background counting the additional headwinds of the war in Ukraine, earnings warnings and selective layoffs, and negative investor sentiment (see our ROOF analysis), it is difficult to figure out what the turnaround catalyst might be, especially until investors can gain more confidence about the economy.

Finally, in all four previous bear-market cases, however, I do remember that quant factors were behaving quite strangely in the months leading up to the market peak – the proverbial canaries in the coal mine. Returns were outsized, and in the opposite direction of what was expected. One bright spot in this market is that despite the turmoil, quant factors have been behaving quite ‘normally’, with returns in the expected direction and in magnitudes we consider relatively subdued. When they do start to ‘misbehave’, it might be a signal that the turn is coming — and in this case it would be to a positive path.


[1] The prior bear market started in November 1980 and ended in August 1982, coincidentally my first month working on Wall Street. Although its end coincided with our data set, its beginning did not, so I was not able to use it for comparison. I recall that the Fed cutting rates in August had an immediate and positive effect on US equities.


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