May 11, 2020
The stock market is still well below its February all-time-high, but it’s holding up remarkably well considering how poorly the economy is doing right now:
- Double-digit unemployment,
- 20+ million jobs lost according to the BLS payroll employment data,
- 30+ million jobs lost according to the sum of weekly unemployment claims since March,
- -4.8% GDP growth in the first quarter (annualized rate) and possibly a 10% drop quarter-on-quarter in Q3, which would be reported as a 34% drop annualized!
- And a whole host of other economic indicators that look so bad, you’d have to go back to the Great Depression to find similar readings
Actually, “holding up” is a bit of an understatement when you look at the stock market as of the Friday, May 8 close:
- The S&P 500 TR index rallied 31% since the March 23 low!
- We’ve recovered more than half of the drop peak to trough!
- Since April 8, we’re no longer 20% below the recent all-time-high, which is often quoted as the cutoff for the Bear Market!
Does that mean the Bear market is over now? I certainly hope so! Whether the Bear Market is over and a new Bull Market might have started already obviously depends on the definition of Bull vs. Bear. What is that definition of Bull vs. Bear anyway? Different people have different definitions, some more sensible than others. And it gets more complicated: even if we do agree on a sensible definition, there could still be uncertainty over what’s the state of the market right now because some criteria cannot designate the state of the world in real-time but only after the fact. There’s a confirmation lag! So, we could be in a sort of a bull/bear-limbo state right now! How is that possible???
So many questions! Let’s take a look at how I think about Bull vs. Bear…
Bear Market Definition
Let’s start with the slightly easier of the two, the bear market definition. That’s often defined as follows:
“A Bear Market is a drop of 20% or more from a recent Bull Market High.”
For example, the 2020 Bear Market was confirmed on March 12 when the S&P 500 dropped by more than 20% relative to its recent all-time-high. (Side note: the Dow Jones already reached that cutoff a day earlier.) In any case, do you notice a subtlety here? There are two distinct dates to consider:
- The Bear Market started on 2/20/2020, the first time we fell below the 2/19/2020 all-time-high.
- The Bear Market was confirmed on 3/12/2020, the first time we fell below the -20% cutoff.
Thus, between 2/20/2020 and 3/11/2020 we were already in a bear market, but we didn’t know it at that time. In other words, …
We were in a Bear Market Limbo between 2/20 and 3/11!
The reason we were in that limbo state was that if the market had recovered from the drop before hitting the -20% and had then reached another all-time-high above the 2/19 level, the Bull Market would have been intact and nobody would have ever talked a Bear market again. Similar to the experience in the fourth quarter of 2018. But, alas, the market did drop below the magical -20% threshold and we confirmed the Bear Market on March 12.
It’s hard to wrap your head around the fact that not everything can be confirmed in real-time. Especially today where all the pertinent information is supposed to be at your fingertips and we’re used to overnight-shipping and even same-day delivery.
But this kind of data uncertainty is all around us. I’m an economist by training and the analog of this type of data headache is the issue of timing the business cycle turning points, i.e., the beginning and end of recessions and expansions. In the U.S. that’s done by the NBER (National Bureau of Research). The NBER doesn’t declare a recession at the first sight of some minor economic weakness. We have to see enough of an economic contraction before a recession is confirmed. And the starting point of the recession will be that earlier date when the weakness began, not the date when it was finally confirmed.
Just like pregnancy is confirmed when the pregnancy test comes back positive. But the pregnancy started at the time when, uhm… well, you know when, right? 🙂
Sometimes this limbo-state really boggles your mind. For example, the 2001 recession started in March 2001 but the NBER didn’t make that announcement until November 2001, which, incidentally was already the end of the recession. And that end of the recession wasn’t declared until July 2003. I can see how people have a tough time wrapping their heads around it. But if you’ve ever done any sort of serious data science you’ll know plenty of examples like this!
Side note: Actually, the NBER faces (at least) two additional challenges over and above the Bull/Bear timing: First, there is no fixed criterion like a 20% drop in stocks. The NBER does not use the often cited naive recession definition of two consecutive quarters of contracting GDP. Rather, the NBER looks at multiple monthly economic indicators. It’s mostly up to the discretion of a committee of Econ Professors to declare what they deem a sufficient contraction. Second, macroeconomic data are delayed and subject to revisions. Especially the Payroll Employment numbers are often revised months and even years after the initial release. Contrast that to the Bull/bear timing. The all-time-high on 2/19 was visible to everybody at the time of the market close and it will never be revised. The (hopefully) Bear Market low on March 23 will never be revised either, so people in finance have much easier data to deal with. So, economists have to be a lot smarter than the finance folks to deal with all those data pathologies! 🙂
Let’s now move on to the even slightly more complicated Bull Market definition…
Bull Market Definition
So, what would confirm a new Bull Market? Two definitions I’ve seen floating around recently:
- The market “leaves the bear market territory,” i.e., we cross the Bull Market high minus 20% again.
- A 20% rally from the most recent Bear Market Low
The S&P 500 actually satisfied both criteria recently: On April 8, 2020, the S&P 500 Total Return Index came within 20% of the old all-time high (“leaving the Bear Market Territory”). And on the same day, you also saw a cumulative 20% return over the March 23 low. So, both definitions have recently been used in the popular media calling the end of the 2020 Bear Market.
Unfortunately, the two definitions don’t make a whole lot of sense. It’s because both criteria would have given you nonsensical Bull Market starts during previous events. Case in point, the 2000-2002 bear market, see the chart below
- The 2000-2002 bear market had a 22% rally between September 2001 and March 2002. But that shouldn’t have qualified as a new Bull Market. The 2000-2002 episode is normally considered one single Bear Market event rather than two bear markets with a short Bull Market in between.
- The “leave the Bear Market Territory” definition is even more problematic. In the Spring of 2001, we “left the bear market territory” because the market rallied and came to within about 13% of the old all-time-high. Was that a Bull Market, then? If so, there would have been a new Bear Market starting in May 2001 with a new Bear Market low in September 2001. But then the Spring 2002 recovery would have again come within 20% of that May 2001 Bull Market high. So you would have had at least three separate bear markets straddling two very short bull markets. Not a very sensible Bull Market definition, because the 2000-2002 stretch is normally considered one single event!
So, let’s try another criterion:
The Bull Market is confirmed if we reach a new all-time high. (and again: the Bull Market would have started at the trough, not the day it was confirmed)
Well, that’s certainly a sufficient but not a very good necessary criterion. For example, following the 2000-2002 Bear Market, we didn’t reach another all-time high until 2007, right before the Global Financial Crisis. Does that mean we were in a limbo state for a total of 5 years between 2002 and 2007 while the market rallied quite substantially? Would anyone argue that if the Global Financial Crisis had arrived a little bit earlier without reaching a new high, that essentially the entire decade was one long Bear Market? Probably not. The “all-time high” criterion is probably a bit too restrictive.
Another example of the “all-time high” criterion being too limiting: The market didn’t reach its 1929 all-time high until the 1940s. But it’s commonly assumed that 1932-1937 constituted a new Bull Market even though the 1937 high was still slightly below the 1929 level.
“a 20% advance off of the prior low that does not get undercut within six months“
I actually like this definition a lot because it eliminates all of the past temporary bear market retrenchment (to my knowledge) but also allows for a reset and a new Bull Market high even if it’s below the previous all-time high (e.g. 1932-1937).
So, using that sensible definition, we still find ourselves in the dreaded limbo state right now. We cannot say for sure if we’re currently in a new Bull Market or if we’re still in the Bear Market that started in February. It all depends on how the market moves from here, see the chart below:
- Bottom Left: If we drop below the March 23 low over the next few months, we are still in the same ugly Bear Market.
- Top Right: If we bounce around for the next roughly 5 months and we get to October 8 (= April 8 + six months) without a new low, then we are indeed in a new Bull Market, even if we haven’t reached a new all-time high. And any new bear market after that would be considered a separate event. Either way, we’re going to be in this limbo state for another close to 5 months, until October 8. Ugh!!!
- Bottom Right: If we reach a new all-time high in the S&P 500 we would consider the entire path from March 24 to that day a new Bull Market.
Why is the stock market holding up so well in the first place?
Obviously, we can yap and yap about the Bull vs. Bear but that’s all semantics. The more pressing question, of course, is why are people talking about a Bull Market in the first place if the economy is so awful? I’ve written about it in previous posts, see the “Reasons for Optimism” and the “Financial Lessons from the First Quarter” posts. I also still stand by the points I made on the April 20 ChooseFI podcast “Have we seen the Bottom?” But I may write another update on my thoughts in the future. Stay tuned! 🙂
There’s a good chance that we’ve entered a new Bull Market starting on March 24 this year. But we’ll have to wait a little bit longer for the final confirmation. That doesn’t sit really well with a lot of people who have to know the information right away. People are so impatient these days, especially journalists! But it’s the nature of the beast, that the sensible bull vs. bear definitions all have a confirmation lag built-in. Bull/bear markets, recessions/expansions and pregnancies all have that in common: a confirmation lag.
There’s nothing we can do about it, so just sit back and enjoy the ride. Decades from now, I will tell my grandkids about how I navigated the great 2020 Bear Market and the subsequent Bull Market. Even though I had no clue in real-time when the Bear ended and the Bull Market started.