Fool.com: What Is a Bear Market? [Retiree Portfolios] July 17, 2000

Retiree Portfolio What Is a Bear Market?

Using a classic definition of a bear market, we can say there have been nine bear markets in the last 50 years. In the worst, it took 90 months, or 7 1/2 years, to go from the market peak to the bear's trough and back to the former peak. However, returns are time-sensitive, so when you begin to measure those returns will determine how a bear market will affect you personally.

By David Braze (TMF Pixy)
July 17, 2000

The only skill I seem to have been born with is that of making mistakes. In fact, I'm so skilled in that regard that I made two mistakes in last week's column, as two alert readers pointed out to me. It's embarrassing to me when I do that, but it would be even more embarrassing to discover no one noticed. At least now I know for certain someone out there actually reads this column. There's some comfort in that.

Besides, they weren't stupid mistakes anyway. Of course they weren't! Only other people make those. Instead, just like a politician, I made "unavoidable errors," a much clearer definition of what actually happened. Everyone knows that an error doesn't become a mistake until you fail to correct it. Like every good Fool, I'm correcting my errors this week. Therefore, I didn't make any mistakes at all. And, that being the case, why are we having this discussion in the first place?

Because we believe in scrupulous honesty in all things Foolish, that's why. Therefore, I am obligated to tell you where I erred. It all began when I joined Harry Potter at the Hogwarts Quidditch field to help him prepare for Task 3 of the Triwizard Tournament.

As you recall from last week's column, I was discussing bear markets, and I said, "I know that over the last 50 years the longest bear market in stocks -- from peak to trough to former peak -- was roughly five years and nine months." Sadly, there are two errors in that simple statement. Apparently, the thought that Harry once again was facing the imminent threat of evildoings from He-Who-Must-Not-Be-Named caused me to imbibe too much purple potion, for I completely forgot to define "bear market" in precise terms.

Worse, I said a bear market lasted from peak to trough to former peak. Even a first-term Hogwarts student unskilled in the most rudimentary of magic arts knows a bear market goes from peak to trough while the recovery period goes from trough to former peak and beyond. I deserved to lose my ability to cast spells for a week over that silly slipup. So, let's take a swig of Veritaserum and correct things a mite.

I define a bear market as a decline in my portfolio of 5% or more that lasts longer than two hours. That works for me. You, though, may wish to use a different definition. There certainly are plenty of them out there from which you may choose.

Vanguard says, "One generally accepted definition of a bear market in stocks is a price decline of 20% or more over at least a two-month period." Ultra Financial Systems defines it "as a market that loses 15% as measured by a stock market index such as the Standard and Poor's 500 Index (S&P 500) which consists of the stock prices of 500 U.S. corporations." And About.com has this to say on the topic: "A common rule of thumb states that if the market is down 10%, it's a Market Correction, and if it's down 20%, it's a Bear Market. While common, it's not very useful. There is a better way." The site then goes on to list some 12 factors that will help you determine what's going on in the stock market.

We can see, then, that there is no really precise definition of a bear market. It's rather in the eye of the beholder; however, I can live with the 20% decline, provided the index used is clearly specified. For stocks, I prefer the Standard and Poor's 500 Index as adjusted for splits and dividends.

Looking at that index, and as I said last week, there have been nine bear markets meeting that definition in the last 50 years. Where I erred the second time was in saying the longest was five years and nine months from peak to trough to former peak. That period was from trough to peak. In reality, the peak-to-peak numbers are as follows:

Months to Recovery from a Bear Market Decline
 
                                        Gain/Loss
                              Mos Down    5 Yrs
Peak      Decline  Recovery  From Peak  from Peak
8/2/56    -21.47%   9/24/58      26       34.85%
12/12/61  -27.97%    8/3/63      21       14.26%
2/9/66    -22.18%    5/4/67      15        3.67%
11/29/68  -35.91%    3/6/72      39      -10.00%
1/11/73   -48.20%   7/17/80      90      -25.37%
9/21/76   -19.41%   8/15/79      35        8.73%
1/6/81    -25.85%  10/20/82      22       52.51%
8/25/87   -33.51%   7/26/89      23       22.22%
7/16/90   -19.92%   2/13/91       7       51.75%

Averages: -28.27%                31       16.96%

Source: Yahoo.com Finance Historical Quotes

Note that, contrary to what I said last week, the longest time from peak to trough to peak is 90 months, and the average loss was some 28%. The bear market itself lasted 21 months, but from that bottom it took another 69 months to regain previous market value. Note also that the average time from peak-to-peak was 31 months. And, perhaps even more importantly in relation to asset allocation, note that from the start of a bear market onset (i.e., at the former peak), five years later the average gain was nearly 17%, but twice (due to the nasty '70s) there was actually a loss.

But (and there's always a but), that ain't the whole story folks. Overall, that's what the market did based on the exact date when it reached a high and began a decline. On an individual basis, never forget that returns are time-sensitive, and much depends on when you begin to measure those returns.

Let's look at roughly the same bear markets with one difference. This time we will use Ibbotson data that is reported on a month-end basis. We'll begin with the yearly month-end high for the bear markets shown above, and measure loss and the duration of any decline from that point. That result is shown below.

Months to Recovery from a Bear Market Decline
(Data as of month-end)

                                         Gain/Loss
                              Mos Down     5 Yrs
Peak     Decline  Recovery   From Peak   from Peak
Jul-56   -14.28%   Jul-58       25         61.34%
Dec-61   -22.29%   Apr-63       17         32.01%
Jan-66   -15.64%   Mar-67       15         22.03%
Nov-68   -29.24%   Mar-71       17          4.09%
Dec-72   -42.63%   Jun-76       43         -1.04%
Dec-76   -14.12%   Jul-78       20         47.52%
Nov-80   -16.92%   Oct-82       24         83.79%
Aug-87   -29.53%   May-89       22         48.79%
May-90   -14.70%   Feb-91       10         71.50%

Avg.:    -22.15%                21         41.12%

Source: Ibbotson Associates EnCorr Software

As the song says, what a difference a day makes! Note that, using Ibbotson data, at least three of those periods would not qualify as a bear market under classic definitions, nor would another two under the "20% decline" criterion. Also, the average loss dropped to 22% and the average peak-to-peak period fell to 21 months, with the longest coming in at 43 months. And, more interestingly, the five-year return climbed to 41%. For me, that data provides even stronger support for the asset allocation approach I use and discussed last week.

The moral I see here is that a bear market means one thing to the professional analysts, but it may mean something entirely different to me. Unless I invested my money on the exact day of the market high, on a personal level I might not experience a bear market at all. It all depends on what day I use to measure my return. That doesn't mean I wouldn't be distressed, mind you. I might have started my year on January 1 with $10,000, watched it climb 25% to $12,500, and then saw it drop 20% to return to $10,000 by December 31. Technically, I neither gained nor lost for the year, so for me the "bear" doesn't exist. But, I also doubt seeing my paper profit vanish due to market gyrations would make me feel too happy, either. How would you react?

That's enough true confessions for today. Next week: Bond ladders. Until then, post away as usual on the Retired Fools board.

Best to all...Pixy