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Tackling The Bear: History Versus Present

FYI | Jul 20 2022

Bear markets have typically been great entry points for long-term investors and 2022 will probably be no different.

-Inflation and interest rates raise memories from the 1970s
-Record levels of global debt are changing the role of central banks
-What does history reveal about bear markets and recessions?

By Danielle Ecuyer

Within an historical context the 2020 bear market was an anomaly.

Short and sharp, thanks to the US$10trn injection of liquidity from the US Federal Reserve and other central banks.

As share markets have been in a secular bull market since 2009, many investors have either never experienced or have faded memories of how bear markets perform and how long they last.

In seeking a bottom for shares, we turn instead to historical precedents to provide answers to ‘is it time to buy yet?’

Setting the stage in 2022

History never repeats but it rhymes.

2022’s bear market started early January and has delivered a circa -20% fall in the S&P500.

The current debate around whether the US and the world are entering a global recession is largely dependent on how stubbornly elevated inflation remains and how much central banks raise interest rates.

What we do know is that the speed and size of this cycle of US rate hikes are comparable to the early 1980’s when then Fed Chairman Volcker induced two back-to-back recessions to squash the inflationary demon of the 1970’s.

Commentators continue to draw comparisons to the 1970s (high energy prices, high inflation, low growth, and low unemployment) when stock markets experienced a secular bear market, starting in 1966 and not finishing until 1982, according to Ned Davis research.

The world has changed a lot since the 1970s, so comparisons may be too simplistic.

One of the greatest concerns to policy makers and central bankers is how to tackle elevated inflation and higher interest rates in a more heavily indebted world.

According to the Institute of International Finance (IIF), global debt is estimated to have risen to US$305trn or over 350% of global GDP.

Michael Howell from CrossBorder Capital, an acclaimed expert in global liquidity analysis, continues to advocate monetary policy is more akin to a global refinancing system.

Howell estimates US$60trn per annum needs to be refinanced as the average maturity of the global debt is 5 years.

Navigating Valuations and Earnings in a Bear Market

ClearBridge Investments offers up some great statistics for investors in its recent report “The Long View: Are we there yet? The ClearBridge anatomy of a recession”.

The report highlights ‘recessions’ are integral to how a bear market performs in both longevity and the depth of the drawdowns.

The following chart from Clearbridge depicts:

-“Recessionary Bear Markets have an average duration of 17 months and fall 39%.”

-“Non-Recessionary Bear Markets have an average duration of 13 months and fall 28.2%”

The latter would infer we are halfway through the bear market if economies avoid recessions or a hard landing.

There are two components to bear markets, the change in valuation multiples and company earnings.

To date the S&P500 valuation, as per Price-Earnings Ratio, has fallen to 15.8x from 21.3x as interest rates have risen.

The longer-term historical bear market average valuation is closer to 12x.

In the last 20 years a higher valuation prevailed, around 14x, which relates to the lower interest rate environment compared to previous periods.

The second component is earnings.

Share markets are forward looking and earnings forecasts to a large degree depend on the macro-economic view, i.e. are economies entering a soft landing or deeper recession?

Jonathan Pain, author of The Pain Report, stated recently in the podcast “The BIP Show”, he is expecting earnings of US$200 per share for the S&P500 in 2022.

Applying a 15x PER multiple, the index level equates to 3000 for the S&P500 or another -28% fall.

Placing this forecast in context: Yardeni Research has S&P500 2021 earnings at US$208.53 and halfway through 2022 consensus forecasts stand at US$215 and $235 in 2023.

Even accounting for the strength in energy prices in the first half of 2022, current earnings forecasts could prove to be overly optimistic if the rate hikes have the desired effect of slowing demand.

Bank of America recently cut earnings estimates for the S&P500 to $218 in 2022 and $200 in 2023, downgrading the calendar year end S&P500 index to 3600 with scope for falls as low as 3000-3200, before recovering.

BofA’s head strategist noted “No two recessions are alike. The market typically leads the economy, peaking before recessions begin and troughing before recessions end”.

The following diagram of potential S&P500 outcomes based on various earnings estimates and valuations was circulating on Twitter and reflects how sensitive the index is to changes in these two factors.

Blackrock is equally negative on equities in the short term and recently downgraded developed markets to underweight in its “2022 midyear outlook”, while stating: “see an increasing risk of the Fed overtightening”.

Blackrock envisages higher levels of inflation in the future as central banks vacillate between maintaining reasonable levels of growth and targeting higher inflation, which in turn will lead to shorter economic cycles and higher risk premia for bonds and equities.

Ned Davis Research sees supply chains easing and inflation peaking and thus envisages a soft landing with its analysis suggesting we are experiencing a cyclical bear market inside a secular bull market.

Ned Davis believes there is insufficient evidence a 1970’s secular bear market will play out but nevertheless remains underweight global equities and bonds, and overweight cash.

Ned Davis notes valuations have become reasonable, but earnings expectations continue to look too elevated with the risks of a severe recession still rising.

CrossBorder Capital is happy to share its views via Twitter, unabashedly tweeting “we are in the ‘not different this time’ camp”.

In plain terms, Crossborder Capital is saying aggressive Fed tightening will create a credit crisis or systemic shock (remember the high debt levels) which causes the Fed to pivot back to QE.

Historically Bear Markets are Good Buying Opportunities

Clearbridge also examined the returns post bear markets for investors, as shown in the next chart.

The conclusion: “regardless of whether we achieve a soft landing, or if the market low has already occurred, bear markets have historically been good entry points for long-term investors”.

Reading the Tea Leaves

Without the magic tea leaves, investors can only operate with the information to hand.

We can use history as a guide to assist us in allocating our cash to shares on a risk adjusted basis that works for us.

Nothing lasts forever and this time might not be as different as what the perma bears are leading us to believe.


Danielle Ecuyer has been involved in share investing in Australia and Internationally for over three decades, both professionally and personally and is the author of ‘Shareplicity. A simple approach to investing’ and ‘Shareplicity 2. A guide to investing in US stock markets’.

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