Bear Markets: Lessons from the past

July 29, 2020 5:15 AM

The pace of market rebound, at least so far, is reminiscent of the less impactful bear markets

One category consists of huge bear markets that sustain long enough to cause tremendous and lasting damage not just to investor wealth and psyche, but also to the economy.One category consists of huge bear markets that sustain long enough to cause tremendous and lasting damage not just to investor wealth and psyche, but also to the economy. (Representative image)

By Vipul Prasad

The decline in global equity markets—which nosedived by more than 30% in February-March 2020—seemed unprecedented. However, the stunning pullback—by more than 35%–since then has further astounded investors. Understandably, the big question now is if the recent rally is sustainable, or can the markets at least hold the current levels, or are we set up for another sharp dip from here.

Based on duration, intensity and time taken to recover losses, bear markets loosely fall into one of the following two categories. One category consists of huge bear markets that sustain long enough to cause tremendous and lasting damage not just to investor wealth and psyche, but also to the economy. Bear market rallies accompany these; they fizzle out soon and are followed by lower bottoms. Only after 2-3 such false starts is the real bottom established. In the second category, there are many bear markets where, after a nerve-wracking slump, the markets move on quickly as if nothing had happened. These typically follow the so-called steep V-shape recovery.

Four most savage bear markets of the first category are 1929-1932, 1937-1942, 2000-2003, and 2008-2009. There are some aspects where Covid-19 bear market is different from these huge bear markets. Covid -19 has come after a not so great economic performance, except to some extent in the US. Similarly, corporate earnings and stock market performance too had not given too much joy to investors in the last two years, especially in India. In terms of policy response, the massive fiscal and monetary stimulus in large economies so far is different from the above episodes except for the GFC. Potential similarities, on the other hand, are the macroeconomic disruption—harp slowdown in all economic indicators including employment. The extent of decline makes 2020 collapse seem more like these.

Bear markets of the second category are more localised and last for a shorter duration. After making a quick dent on investor wealth, they withdraw without causing lasting damage on investor psyche, or on macroeconomic indicators like economic activity, employment and trade. Roots for such bear markets can be geopolitical, technical, or economic in nature but are typically shallow. For example, in October 1987 a new, sophisticated financial instrument called portfolio insurance imploded after displaying its unknown, nasty side causing a single-day fall of 22% in the USA’s DJIA on the so-called black Monday. The market recovered its entire losses in just about 20 months. Similarly, the oil crisis of 1973 too had been caused by exogenous factors. Arab oil-producing countries had decided to cut off crude oil supplies to countries that they perceived to be supporting Israel in the Arab-Israel war. Oil prices had shot up by 300% in no time, and the oil crunch was felt across the developed world. DJIA recovered to its earlier levels in 16 months.

The current bear market is the first one in hundred years that has been sparked by a pandemic. Further, few downturns have been as widespread in their socio-economic ramifications. Accordingly, markets have tracked economic expectations more directly. Investor emotions have played a lesser role here.

The pace of market rebound, at least so far, is reminiscent of the less impactful bear markets. Also, like typical second category bear markets, Covid episode is exogenous. Factories that produce goods and services are still standing. Managers and owners, as well as employees too, are available. The key is to take care of banking and financial systems. However, this will depend on humanity’s success in controlling Covid-19 pandemic. If a second, stronger wave of Covid erupts, it can have a meaningful impact on global socio-economic systems and markets. That would be more in line with the huge bear markets that not only induce some course correction and learning for policymakers and investors but also cause an enduring effect on the way common man lives, works and plays.

The author is Founder & CEO, Magadh Capital LLP

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