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There’s a bear in there – what drives mild versus deep bear markets


Key points


- Historically, bear markets in Australian shares have seen an average fall of 33% over 18 months.  

- However, this masks a huge range. 65% of bear markets have seen gains over the 12 months following an initial 20% decline in share prices.   

- Factors involved in whether bear markets are mild or deep include whether there is a recession, whether earnings slump and whether the market was overvalued or not prior to the start of the bear market.  

- Our view remains that a recession is unlikely, that earnings growth will be soft but is not about to implode and valuations are not  stretched.  


Introduction


News that the Australian share market as measured by the ASX 200 index briefly slipped  into bear market territory last week as defined by a 20% decline from the most  recent high – which in this case was April last year – has generated much coverage and interest and understandable concern. This note takes a look at what bear markets are, how deep & long they have been and points out that  they are not all of the big bad grizzly variety.

What's a bear market?

Unfortunately there is no agreed definition of a correction versus a bear market – and certainly no "official" who makes declarations on this. My preferred approach is that a correction is  limited to sharp falls, across a few months after which the rising trend in share prices resumes, taking shares back to new highs within say six months of  the low. By contrast, a bear market sees falls lasting many months or years  with a pattern of falling lows and highs and it takes shares a year or more to regain new highs.

A common approach is to use a 20% or more decline to delineate a bear market from a correction. Of course this is rather arbitrary – and right now it puts the ASX 200 as having entered a bear market (because it fell 20% from its high in April last year to its low last week),  but not the broader All Ordinaries index which has "only" had a 19% fall. But I  guess the line has to be drawn somewhere.

How long do Australian bear markets last?

The following table shows bear markets in Australian shares since 1900 using the  20% rule.

Bear markets in Australian shares since  1900                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

      Bear    markets in Aust shares

Mths to low

% fall

Mths after low to make new high

% gain in first 12 months after low

Jun 14-Dec16

30

-22

37

+10

Jul 29-Aug 31

25

-46

38

+33

Mar 37-Apr 42

61

-32

43

+30

May 51-Dec 52

19

-34

62

+8

Sep 60-Nov 60

2

-23

33

+12

Feb 64-Jun 65

16

-20

25

+9

Jan 70-Nov 71

22

-39

94

+52

Jan 73-Sep 74

20

-59

59

+51

Aug 76-Nov 76

3

-23

21

+5

Nov 80-Jul 82

32

-41

17

+39

Sep 87-Nov 87

2

-50

75

+35

Aug 89-Jan 91

15

-32

30

+39

Aug 91-Nov 92

15

-20

5

+54

Feb 94-Feb 95

12

-22

20

+25

Mar 02-Mar 03

12

-22

15

+27

Nov 07-Mar 09

15

-55

?

+55

Apr 11-Sep 11

5

-22

16

+12

Avg from 1900

18

-33

37

+29

Avg from 1950

14

-33

36

+30

Apr 15- ?

10 ?

-20 ?

?

?

Based on the All Ords, excepting the ASX 200 for the latest. I have  defined a bear market as a 20% or greater fall in shares that is not fully  reversed within 12 months. Source: Global Financial Data, Bloomberg, AMP Capital

Since 1900, Australian shares have seen 17 bear  markets. These have lasted an average 18 months with an average top to bottom  fall of 33%. It's then taken an average 37 months to exceed the previous high, although we are still waiting in relation to the November 2007 to March 2009 bear  market. The average gain over the first 12 months following the bear market low has been 29%, highlighting the gains that can be made up front once bear  markets end.

Not all bear markets are created equal

Of course this all masks a wide range. The worst bear market was the 1973-74 slump of 59%, which lasted 20 months, as stagflation (ie recession and high inflation) took hold in the Australian  economy. This was followed by the global financial crisis driven slump of 55%  that lasted 15 months. The 1987 crash saw a 50% plunge over two months and the Great Crash of 1929-31 saw a 46% plunge.

At the other extreme there've been several bear  markets of just over 20% including those of 1994-95, 2002-03 and 2011. In fact  of the 17 bear markets since 1900, 11 saw shares higher a year after the initial 20% decline with an average gain of 14%. Of course the remaining 6 pushed  further into bear territory with average falls over the next 12 months, after  having declined by 20%, of an additional 22.5%. Stockbroker Credit Suisse, albeit focussing only on the period from the 1970s, recently called these Gummy  bears and Grizzly bears respectively and since it's a useful way to think of it I will stick to the same terminology.

 

  Source: ASX, Global Financial Data, Bloomberg, AMP Capital

What determines how deep bear markets are?

Because of the role played by investor sentiment and the risk that it can make bear markets somewhat self-feeding there is no definitive answer to this. However, the next table provides some  guide. The first two columns show bear markets since 1900 and the size of their  falls. The third shows the percentage change in share prices 12 months after  the initial 20% decline. The fourth indicates whether they are associated with a recession in the US, Australia or both. The fifth column shows associated top to bottom falls in profits and the final column shows a measure of share market  valuation at the start of bear markets. Worse than average bear markets are in red.

Contributors to the depth of bear  markets in Aust shares                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

      Bear markets in Aust shares

% fall

% chge  12 mths after        -20%

Recession Aust, US or both

Fall in profits

Shiller PE plus inf rate

Jun 14-Dec16

-22

11

Yes

NA

NA

Jul 29-Aug 31

-46

-30

Yes

NA

NA

Mar 37-Apr 42

-32

7

Yes

NA

NA

May 51-Dec 52

-34

-13

No

NA

NA

Sep 60-Nov 60

-23

5

Yes

NA

NA

Feb 64-Jun 65

-20

8

No

No fall

NA

Jan 70-Nov 71

-39

-3

Yes

-28%

NA

Jan 73-Sep 74

-59

-38

Yes

23

Aug 76-Nov 76

-23

8

No

No fall

24

Nov 80-Jul 82

-41

-13

Yes

-28%

27

Sep 87-Nov 87

-50

3

No

-13%

43

Aug 89-Jan 91

-32

10

Yes

-51%

29

Aug 91-Nov 92

-20

54

No

21

Feb 94-Feb 95

-22

16

No

No fall

24

Mar 02-Mar 03

-22

24

Yes

-24%

25

Nov 07-Mar 09

-55

-38

Yes

-53%

38

Apr 11-Sep 11

-22

10

No

No fall

23

Avg from 1900

-33

1.2

NA

NA

NA

Avg from 1950

-33

2.4

NA

NA

28

Apr 15- ?

-20 ?

?

?

?

21

Based on the All Ords, excepting the ASX 200 for the latest. I have  defined a bear market as a 20% or greater fall in shares that is not fully reversed within 12 months. Source: Global Financial Data, Bloomberg, AMP  Capital

Several  observations can be made.

First,  the deeper Grizzly bear markets are invariably associated with recession,  whereas the milder Gummy bear markets and even the rather short (but shocking)  1987 share market crash tend not to be. Just less than half of the Gummy bears saw a recession compared to five of the six Grizzly bears.

Second,  although we don't have earnings data prior to the 1960s, the deeper Grizzly  bears tend to be associated with sharp declines in company profits, notably  those of the early 1970s, early 1980s and GFC bear market. By contrast the milder bear markets such as those beginning in  1964, 1976, 1994 and 2011 often see less earnings weakness.

Finally, valuations are not definitive but they  appear to play a role. To give a guide to valuation I have compared share  prices to a rolling 10 year moving average of earnings because it corrects for cyclical swings in profits (this is referred to as the Shiller PE or cyclically  adjusted PE) and then added the inflation rate to because when inflation is  high PEs tend to be lower and when inflation is low PEs tend to be higher.  Basically the higher this measure is the more expensive shares are. The next  chart shows this measure since the 1970s with vertical lines indicating the  start of bear markets. Bear markets starting in 1980, 1987, 2003 and 2007 all  began with higher readings than average (24.8). Grizzly bears started with an average reading of 30 versus an average of 28 for Gummy Bears suggesting there  is not much in it but that it may be factor.

 

   Vertical lines show the start of bear markets. Source: RBA, AMP  Capital

Implications for investors

Out  of the 17 bear markets in Australian shares since 1900,11 have moved higher over the 12 months following a 20% decline, suggesting that based on history there is a 65% probability that  shares will move higher over the year ahead.

Factors  that play a role in determining whether a much deeper bear market may occur are:  whether Australia or the US have a recession, whether there is a sharp fall in  earnings and albeit with less reliability valuations. In regards to these:

  • Our view remains  that the US is unlikely to experience a recession given the lack of prior  excesses (in terms of cyclical spending, debt growth or inflation) and the  absence of significant monetary tightening.
  •  
  • In Australia, we  continue to see growth tracking along at around 2.5% pa, with recent economic  indicators broadly consistent with this.
  •  
  • On the earnings front, resources earnings have already crashed 80% or so and at 10% of the  overall market their ability to do further damage is limited. Meanwhile, the  profit reporting season underway suggests profit growth in the rest of the  market is meandering along at around 5%.
  •  
  • Finally, the  cyclically adjusted PE + inflation valuation measure at 21 when the current  bear market started was at the low end of the range for the start of past bear markets and at 18 now is close to as low as it ever gets.

These considerations provide some hope that Australian shares will be higher rather than lower in a year's time. The main risk is that gloom and doom about the  global outlook become self-fulfilling, dragging shares lower. The historical  experience suggests that there is a limit to this though and global central  banks seem to be awakening to the risks and so are moving in the direction of  seeking to stabilise financial conditions.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital

Important note: While every care has been taken in the  preparation of this document, AMP Capital Investors Limited (ABN 59 001 777  591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721,  AFSL 426455) make no representations or warranties as to the accuracy or  completeness of any statement in it including, without limitation, any  forecasts. Past performance is not a reliable indicator of future performance.  This document has been prepared for the purpose of providing general  information, without taking account of any particular investor's objectives,  financial situation or needs. An investor should, before making any investment  decisions, consider the appropriateness of the information in this document,  and seek professional advice, having regard to the investor's objectives, financial situation and needs. This document is solely for the use of the party  to whom it is provided.