Blog Posts — March 16, 2020

Steep and Swift So Far, This Dive Isn’t Over, if History Is Any Guide

I have been asked how the current market decline (which officially hit “bear” status last week) compares with other bear markets. Coincidentally, the start of my career in equity markets corresponds almost exactly with the inception of our US equity model in 1982. So I’ve experienced the last three bear markets firsthand. And that experience suggests to me that we 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 level. The data backs this up.

There have been three major bear markets in the 38 years of the model[1]:

  • August 1987 through December 1987 (but remembered most for Black Monday, October 19);
  • March 2000 through October 2002; and,
  • October 2007 through March 2009.

The exhibit below shows the path of the Russell 1000 index from the start of each bear market to the previous high-water mark. I have also included the current slide (through Friday, March 13).

Source: FTSE Russell, Qontigo

Obviously, none of the other bear markets was associated with a global pandemic with such enormous economic impact and uncertainty. In 1987, the market dropped from a wildly overvalued level that many blamed on portfolio insurance and relatively nascent program trading. At the time, I was Head of Quantitative Research at Prudential Securities, writing quantitative commentary. I remember being increasingly alarmed at how overvalued the market was becoming—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 a lofty level, even if the economy did not seem to be in potential trouble. Because there was no real economic issue at the time, the recovery to the prior peak was relatively swift.

When the Twin Towers fell, we were already in a bear market after the bursting of the internet bubble, and it was another year before the market stopped sliding. Although valuations were rich at the internet boom peak, the stock slide brought them more into line 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 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 impact that started in the US was quickly exported. Interestingly, the peak-to-trough period for this bear market was shorter than that of the 2000-2002 crisis, but recovery to the previous high took about the same amount of time.

Although all three of the bear markets since 1987 started with the market at lofty valuations, there is one important difference between then and now. In none of the prior periods were interest rates already so low that there was not very much room for the Fed to maneuver, and that remains a huge wildcard in trying to assess the current market. The exhibit below shows the path of the US 10-year bond yield throughout the duration of each bear market (2020 goes through Friday, March 13).

I suspect the recovery is much more likely to be long and drawn out, much like the 2000 and 2007 markets. And it likely won’t even start until we have better clarity of the path of the virus, which could be months away, according to some reports.

Finally, in all three cases, quant factors were behaving quite strangely in the months leading up to the market peaks—the proverbial canaries in the coal mine. Returns were outsized, and in the opposite direction of what was expected. The behavior of those factors, of course, had nothing to do with the coronavirus, but they may have been signaling that when the exogenous factor came be the reaction would be swift and large. One thing we will be watching closely is when those factors return to normal…


[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.