What History Tells Us about How Far the Stock Market Could Fall

The COVID-19 pandemic resulted in widespread business closures, which created supply chain problems by disrupting workflows across the manufacturing and logistics industries. At the same time, the U.S. government doled out trillions of dollars in stimulus payments in an effort to fend off a prolonged recession, and the Federal Reserve kept rates low and spent trillions of dollars buying up bonds for the same purpose.

On the front end of the pandemic, stimulus payments and loose monetary policy allowed the economy to rebound quickly. But on the back end, the same factors have sent prices soaring, and Russia's invasion of Ukraine has amplified the problem by making oil more expensive. As a result, inflation has now exceeded the 2% target set by the Federal Reserve for 16 consecutive quarters.

That series of unfortunate events has conspired to tank the stock market. With the possibility of a recession looming, some investors have sold stocks to hedge against a potential economic downturn. That domino effect drove the S&P 500 down into bear market territory in June, and the benchmark index is currently 19% off its high. But inflation hit a fresh 40-year high of 9.1% in June, signaling that things may get worse.

How far could the market fall? And how long could the downturn last?

Image Source: Getty Images.

Past bear markets may hold clues

The S&P 500 was first introduced in 1957, and the index has seen 11 bear markets since then, including the current downturn. That works out to one bear market every six years or so.

The chart below shows the severity and duration of each of the past 10 bear markets.

Data source: Yardeni.

Since 1957, the average bear market saw the S&P 500 fall 36%, and it took 391 days for the index to hit bottom. To put that in context, the S&P 500 is currently down 19%, and the index last hit a new high on January 3, 2022, or 195 days ago at the time this article was written. If the current bear market falls precisely in line with the average, we are only halfway through the downturn and the S&P 500 will still fall another 17%.

That being said, historical data will only get you so far. Each bear market has been precipitated by different circumstances, and the severity and duration of each downturn has varied widely. But some economists have drawn comparisons between the current situation and the bear markets in 1973 and 1980, which resulted from persistently high inflation and two oil shocks that sent fuel prices soaring. That time period was also characterized by multiple market corrections, but the S&P 500 ultimately rebounded and returned to growth as inflation moderated.

Ultimately, it is impossible to predict the duration and severity of any market downturn. There are simply too many variables that impact the economy and investor sentiment. With that in mind, the current bear market could pull the S&P 500 down much further, and it could drag on for many months to come. Or maybe the market already bottomed out -- only time will tell.

That being said, I wouldn't be surprised to see the S&P 500 enter a new bull market once inflation reverses course in a meaningful way. At that point, investors will be able to see light at the end of tunnel, which should buoy sentiment.

The silver lining

Bear markets are unsettling, but there is a silver lining for investors. Since 1957, the average bull market saw the S&P 500 climb 184%, and those gains more than made up for any losses sustained during downturns. In other words, the market has always recovered, and there is no reason to believe the current situation is any different.

With that in mind, the best course of action is to invest with a long-term mindset. Now is a great time to put money into the stock market, and an S&P 500 index fund looks like a particularly attractive option for investors who prefer to avoid individual stocks.