Bull Market Correction or New Bear Market

By Charles Rother, CFA & Chief Investment Strategist, Sector Logic, LP

and Chris Rangel, MBA

Since we are only 14 months removed from a vicious bear market and the psychological wounds are still fresh, investors are surely wondering if yesterday’s extreme market volatility is a precursor to another bear market or a correction in the bullish uptrend which began in March 2009? 

To answer this critical question, we analyzed stock market behavior over the last 110 years. To provide you a historical perspective, we organized the last 29 bull markets.  In Table 1, we provide each bull market’s total return and its largest market correction.  By definition a market correction in a bull market is a decline no greater that 20 percent.  If the decline exceeds 20 percent, then the correction is classified as a bear market.

 

The S&P 500 has declined 7.3 percent since April 23, 2010.  This is approximately 5 percent less than the historical average of 12.14 percent for bull market corrections, shown in Table 1.  The question on most investor’s mind is what is the probability of another bear market?

 Table 2 gives some insight into that question.  This provides the probability of additional declines across both bullish and bearish market trends.  Given a 7.3 percent decline in the S&P 500, there is a 77 percent probability that the market will decline an additional 2.5 percent.  More importantly there is only a 34 percent probability that the S&P 500 will decline an additional 12.5 percent, which would put us very close to bear market territory.

 

However, we have experienced a strong bullish trend over the past 14 months and the primary market trend remains bullish.  In the context of this bullish trend, do the probabilities for additional market decline vary from the entire market experience?  Indeed they do as illustrated in Table 3.  With the primary stock market trend bullish and considering the 7.3 percent decline in the S&P 500, there is a 48 percent probability that the market will decline an addition 2.5 percent.  Further, there is only a 2 percent probability that we will encounter an additional 10 percent decline from these levels.

 

Conclusion

Although yesterday’s volatility was unsettling, the probability for an additional 2.5 percent decline is less than 50 percent. More importantly, the probability for additional significant declines, greater than 10 percent, remains small. The important point to remember is that we are dealing in probabilities.  Is another bear market possible?  Yes.  Is it probable?  History tells us the possibility is remote.  In this case, less than 2 percent.  At this point, we view further market weakness as a buying opportunity.



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