A Bear Market Checklist

By Charlie Bilello

11 Nov 2022

The S&P 500 is in the midst of its third bear market in the last four years.

If this one feels different than the previous two, that’s because it’s lasted for more than the blink of an eye.

At 9 months and counting from the all-time high reached back in January, this is now the longest bear market we’ve seen since the 2007-09 collapse. By comparison, the 2020 bear reached its low in just 1 month and the 2018 bear bottomed after only 3 months.

At the same time stocks have been moving lower, bonds have as well.

Over the last 27 months, the US bond market has declined over 17%, the longest and deepest drawdown in history.

This has come as a shock to many investors because the previous 8 times stocks were down in a calendar year, bonds finished higher, cushioning the blow.

That hasn’t been the case this year, and as a result a 60/40 portfolio of stocks/bonds is on pace for its worst year since 2008.

Amidst all the carnage, there are two questions investors keep asking:

  1. How long will the bear markets in stocks and bonds last?
  2. How deep will the declines be before a bottom is reached?

Unfortunately, there’s no answer for either question as every bear market is different. Since 1929, the average S&P 500 bear market has declined 36% over 14 months, but the deviation around that average has been extremely high. And in bonds, we’re already in uncharted territory, far beyond historical declines in terms of both duration and magnitude.

Which means that trying to predict where and when a bottom will occur is a futile game to play.

What should an investor focus on instead? Here’s a checklist to consider

1) Know Your Time Horizon

When markets are marching steadily higher, your time horizon can seem almost irrelevant. But when risk rears its ugly head, nothing could be more important.


Because if you’re investing with money you need over the next month or year, you’re more likely to become a forced seller, turning short-term volatility into a permanent loss. But if you’re investing for the next decade or longer, time is on your side, and all you need is the fortitude to stick with your portfolio through the hard times.

What can help with that is perspective, knowing that every bear market of the past has ultimately been followed by a new all-time high at some point in the future.

Since 1950, the average recovery time (from low to new high) for the S&P 500 (including dividends) has been 14 months, with the longest recovery taking 48 months. If that seems like an eternity, your time horizon may be too short, and not compatible with an investment in equities.

In the bond market, we’ve never seen a full recovery take more than 9 months from a low (with data going back to 1976). But just because something hasn’t happened in the past, doesn’t mean it can’t happen in the future. The depth of the current drawdown (-17%) suggests that the recovery will likely take longer this time around. But if you’re a long-term bond investor, you can afford to be patient, and now at least you’re being paid a higher reward to wait (see #4).

As an individual investor, time is your biggest asset. To utilize it effectively, know your time horizon.

2) Make Sure You’re Really Diversified

Diversification is always important, but during long bull markets that concept often falls on deaf ears. During the 40-year secular bull market in bonds that ended in 2020, owning the total bond market would have served you quite well (+7.6% annualized return from Jan 1981 – Dec 2020 in Bloomberg US Aggregate). And during the final two years (+8.7% in 2019 and 7.5% in 2020) the gains made diversification seem entirely unnecessary.

But past is not prologue in investing, and with yields hitting all-time lows in 2020, bonds as an asset class became nearly all risk with no reward.

The only way to reduce the duration risk in the aggregate indices was to look different, allocating a higher percentage of your bond portfolio to vehicles with a lower sensitivity to interest rates. That additional diversification has paid dividends so far this year, with short-term Treasuries (ex: $BIL ETF, +0.79%) and short-term corporate bonds (ex: $JPST ETF, +0.16%) both posting positive returns. Duration is not the only diversifier with the fixed income space, however. Credit can also provide benefits as evidenced by floating rate leveraged loans (ex: $BKLN ETF, -3.42%) which have far outpaced the aggregate indices this year.

Note: As of 11/3/22

Within the equity market, diversification had been equally dismissed over the last decade, with concentrated portfolios in high growth stocks (ex: $ARKK ETF) and the Nasdaq 100 ($QQQ ETF) far outpacing everything else. But there’s a cycle to everything, and the 14-year run of growth outperforming value has started to revert back to the mean.

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As a result, we’ve seen value outperform by a sizable amount this year (ex: $IUSV ETF, -8.93%) while sectors with lower valuations like Energy (ex: $XLE ETF, +68.04%) have trounced everything else. Additionally, defensive areas like low volatility (ex: $SPLV ETF, -9.81%) have held up significantly better than the Nasdaq 100 (ex: $QQQ ETF, -34.20%) and high growth stocks (ex: $ARKK ETF, -61.73%).

Note: As of 11/3/22

Entering 2022, a 60/40 portfolio of US stocks and bonds had experienced their best 3-year run since 1999, with a cumulative return of 58.8% (60% S&P 500, 40% Bloomberg US Aggregate).

And just like back then, this was an opportune time to seek diversifiers with a low correlation to either asset class (see “Betting Against Buffett”). We’ve seen that in spades thus far in 2022, with areas like managed futures (ex: $AMFAX, +46.15%) and merger arbitrage (ex: $MERIX, +0.23%) posting gains amidst the downturn in stocks and bonds.

3) Look for Opportunities to Rebalance

Volatility in markets tends to create wider dispersion in asset class performance. This can lead to big shifts in your portfolio weightings and opportunities to rebalance. One of the most glaring of these opportunities today are in international equities, which have been underperforming their US counterparts for nearly fifteen years.

A ratio of the S&P 500 to the rest of the world is currently at its most extended level in history, likely leaving an outsized position in US stocks in many portfolios. No one knows what the future will bring, but as we’ve seen with growth and value, a cycle can turn at any point. When it does, having some exposure to equities outside the US will prove beneficial.

Rebalancing is ultimately a risk management tool, taking profits in areas that have done extremely well on a relative basis and adding to areas that have lagged. You do this not only to increase exposure to lagging areas which are often unloved/cheaper, but more importantly, as protection against sharp reversions to the mean that can add unwanted volatility to your portfolio.

4) Focus on the Bright Side

During bear markets, there’s always a long list of things to worry about, and this one is no exception. From recession fears to runaway inflation to the threat of nuclear war, all of the news today seems to be bad news.

It’s tempting during such times to move entirely to cash, which has handily beaten both stocks and bonds in 2022. But this is short-term focused and backward looking. As your time frame lengthens, the odds that cash will be the best performing asset class declines considerably.

And that becomes more and more true the “safer” cash seems to be. That’s because after long bear markets in stocks and bonds, valuations fall and yields rise, making stocks and bonds more difficult to beat.

In Treasury bonds, we haven’t seen yields this high since 2007.

With a 97% correlation between starting 10-year yields and future bond market returns, this is great news for long-term bond investors.

On the equity side, we entered the year with the highest US stock valuations since 2000, which have since moved down by a considerable amount.

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While still not anywhere near “cheap” (CAPE ratio of 28 remains in the highest decile), they’re certainly cheaper than they were. And should the declines deepen from here, the potential future rewards would only continue to improve.

No one can tell you where and when the bear markets in stocks and bonds will bottom. And that’s ok, because predicting the future is not a prerequisite for success in investing.

If you know your time horizon, make sure you’re really diversified, look for opportunities to rebalance, and focus on the bright side, you can withstand just about anything that comes your way.

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Disclaimer: All information provided is for educational purposes only and does not constitute investment, legal or tax advice, or an offer to buy or sell any security. For our full disclosures, click here.

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