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3Q 2021 Quarterly Letter - Not All Bear Markets are Alike

"Success is not final, failure is not fatal. It is the courage to continue that counts" - Winston Churchill

Last winter we experienced the shortest bear market in US history.  It lasted only 33 days. The S&P 500 peaked February 19th and bottomed the following month, March 23rd. The market fell 34% from its February high to its March low. The average decline for bear markets is about 37%. However, it was the short duration that distinguishes this most recent bear market. Going back to the Great Depression the median bear market lasted 302 days. Upon closer examination it turns out the short duration of last year’s bear market may not in fact be all that surprising because not all bear markets are alike.

In fact, there are three different types of bear markets: cyclical, event driven and structural. 

Cyclical Bear Markets 

Cyclical bear markets are a function of the business cycle. A bear market could stem from slowing growth, higher interest rates, declining loan activity and slowing demand. A cyclical bear market requires time for the economy to sort itself out regaining its long-term growth rate trend. During this period interest rates may fall and the government may attempt to boost the economy with fiscal stimulus leading to a recovery in both the market and economy. Historically, cyclical bear markets last over two years and take an additional two years to recover. I would assert that the bursting of the tech bubble in 2000 was in all likelihood a cyclical bear. The Fed raised interest rates. The economy slowed and the market sold-off, particularly technology and internet companies .

Structural Bear Markets 

The most recent example of a structural bear market is the financial crisis in 2008-2009 and these types of bear markets have generally been the most severe throughout history. Structural bear markets usually stem from too much leverage, credit fueled asset bubbles and rising defaults. Structural bear markets have historically lasted the longest, averaging over three years and take an additional six years to recover. The length of both the bear market and its recovery is largely explained by the Great Depression, also a structural bear market. So, it’s no surprise that many of you will recall comparisons being made between the financial crisis and the Great Depression.    

Event-Driven Bear Markets  

These bear markets are driven by unexpected events like the Covid-19 global pandemic. It’s the type of bear market that we experienced last year. These types of bear markets are characterized by events such as a global pandemic, an oil shortage, war or political instability. Historically, event-driven bear markets have lasted on average nine months. That 33 days in duration was quick, the quickest on record. The magnitude of the decline however does not deviate much from what we would expect given history.  However, it would only take the market, as measured by the S&P 500, five months after bottoming to make a new high in August last summer.

Of the three types of bear markets, we have several examples of each throughout history. We know that structural bear markets have typically been the worst as measured by their duration, depth (magnitude of loss) and length of time needed to recover. Event-Driven bear markets are the shortest in duration, depth (magnitude of loss) and length of time to recover. Last year’s Covid bear market largely is in keeping with this pattern. While the duration and length of time to recover were significantly shorter than average the market did in fact decline by approximately the amount one would expect from an event-driven bear market. 

We now know, with the benefit of hindsight, that last year’s bear market ended while the news surrounding Covid continued to get worse.  The market is what is known as a (forward) leading economic indicator.  It’s one reason many have a hard time accepting that the market can be powering higher, making new highs while the current headlines can be so bad.  One thing I takeaway from the sharp suddenness of last year’s decline and rapid recovery is the market action illustrated the futility of market timing.