Most investors consider stocks to be in a bear market when they're down at least 20% from the most recent high. By this definition, the S&P 500 hasn't been in a bear market for nearly two months. The Nasdaq Composite Index remains in bear market territory, but just barely (no homophone-related pun intended).
However, some think that the overall stock market is still in a bear market. They fear that recent gains will turn out to be nothing but a head fake.
Are we in a new bull market or just a bear market bounce? Here's what history shows.
Previous bear markets
Since 1950, the S&P 500 has fallen from its previous high by 20% or more nine times. Prior to this year's sell-off, the most recent bear market occurred in 2020 with the COVID-19 pandemic. After a steep plunge, stocks quickly rebounded and returned to solid growth.
The COVID-19 bear market was unusually brief and should be viewed as something of an outlier. However, several other bear markets over the past 72 years similarly transitioned into clear bull markets.
For example, stocks bounced back strongly after the bear market in the early 1980s. Our current conditions mirror that period in some ways, including high inflation combined with a Federal Reserve committed to interest rate hikes to curb inflation.
There are less encouraging historical precedents, though. In the early 1960s, the S&P 500 initially appeared to rebound only to fall again nearly to its previous low. Only after forming this "W"-shaped chart did the market mount a full-blown recovery.
The 1970s also provides a scenario that wasn't great for investors. The S&P 500 plummeted in 1973 and 1974. Stocks emerged from bear market territory briefly in 1975 only to slide again. Even when the market came back, it remained range-bound for several years and didn't recover its previous high until 1980.
The S&P 500 has rebounded by nearly 15% from its low this year. Historically, this kind of strong move typically turned into at least a modest bull market rather than a temporary bear market bounce.
Some encouraging signs
While looking back at the past can give some clues about what might happen going forward, looking at the present is more helpful. What matters most for the market right now is inflation.
If inflation remains sky-high, the Fed will continue to crank up interest rates. That could, in turn, lead to another stock downturn. However, there are some encouraging signs that this scenario could be avoided.
July data revealed that the U.S. inflation rate has possibly peaked. This is often (although not always) a good sign that stocks will rise.
Since this data came out, gas prices have fallen significantly. House prices have also declined for the first time in three years. The inflation rate could indeed be headed lower. If so, the probability that the stock market is in a new bull market rather than a bear market bounce should be relatively high.
The smartest strategy
We really can only speculate as to what will happen with stocks over the near term. That's why the smartest strategy for investors is to buy stocks that should have strong growth potential over the long term. And ones that could fare relatively well regardless of what the overall market does in the coming months should be especially attractive.
I think that Vertex Pharmaceuticals (VRTX 1.70%) stands out as a great example. The biotech stock has soared this year despite the overall stock market malaise. Vertex continues to generate strong revenue and earnings growth thanks to its cystic fibrosis (CF) therapies.
The company could soon move into new indications. Vertex and its partner CRISPR Therapeutics are close to filing for regulatory approvals of exa-cel. The gene-editing therapy holds the potential to effectively cure rare blood disorders sickle cell disease and transfusion-dependent beta-thalassemia. Vertex also has a pipeline that's chock-full of promising candidates, including non-opioid pain drug VX-548.
As an added bonus, the stock is a bargain in light of its growth prospects. Vertex's price-to-earnings-to-growth (PEG) ratio is only 0.43. Any PEG value below 1.0 is considered an attractive valuation.
Maybe we're in a new bull market; maybe we're not. Either way, buying stocks such as Vertex should be a winning move.