Stocks rebounded strongly last week but that doesn’t mean the danger has passed, as snapback rallies often occur in bear markets. So is this a run-of-the mill correction or is a bear market looming?
You can't use fundamentals to nail the bottom, says Ritholtz Wealth Management's Ben Carlson. Looking at past corrections and bear markets, he found valuations were all over the place at market bottoms. Sometimes stocks were cheap, sometimes they were expensive – there was no discernable pattern.
Valuation fundamentals are “basically useless” when it comes to market bottoms, says Carlson. What is important is whether a correction takes place in a recessionary or non-recessionary environment.
Unsurprisingly, non-recessionary corrections are much milder. Stocks fall an average of 15.1 per cent in non-recessionary corrections, compared to 29.1 per cent during recessions. Furthermore, drawdowns have historically lasted almost three times as long during recessions.
Bear markets outside of a recession are rare, only occurring twice since 1950. That said, there have been four occasions where stocks came very close to bear-market territory outside of a recession, falling 19 per cent (most recently in 2018 and 2011).
Still, analysts at Goldman Sachs and JP Morgan are making the case for stocks, saying risk is limited due to low recession odds. “Unless the economy goes into a recession,” agrees Carlson, “it would seem a correction is more likely than a crash in the current environment.”
