October 28, 2018

What to Expect in a Bear Market for Global Stocks

Key Points

  • Recent stock market behavior and our belief in heightened risk of a peak in the global economic cycle in the next 6-18 months, makes it a good time to consider what has happened to stocks in a typical recession and bear market.

  • In general, stocks tend to peak before the recession, bottom a year after the recession starts and take about 3.5 years to recover the losses.

  • Setting expectations is important to avoid surprises that might cause an investor to abandon their long-term plan.

Stock markets around the world seem to be retracing their usual late cycle path and may be signaling a recession and bear market right around the corner, as you can see in the chart below of the MSCI World Index. If so, it may be worth looking back at what a typical recession and bear market looks like.

Performance of MSCI World Index ahead of past 6 global recessions

global bear market graph

It is a striking chart, but I'd caution on reading too much into the path for stocks in the near-term. Stocks may not continue tracking the pattern above. In fact, it seems a bit early for them to do so. The stock markets current path suggests we are mere weeks away from the start of the next global recession. However, our assessment is that the global economic cycle has a bit longer to run. We have recently published articles on why time-tested indicators of the end of the global economic cycle, including the yield curve and gap between unemployment and inflation, suggest to us that the global economy may not peak for another 6 to 18 months. That said, we may be near enough to consider what usually happens when the cycle peaks so we can be prepared and know what to expect.

What to expect
The nearly 50 years of history for the MSCI World Index includes six global economic cycles and a wide range of environments that contain periods of geopolitical conflict and relative world peace, U.S.-led trade protectionism and broadening free-trade, high and low interest rates, and many other varied conditions. We can see in the chart that, on average:

  • Stocks peak about six months (26 weeks) ahead of the start of the recession. 
  • Stocks bottom about a year after the recession starts.
  • After bottoming, stocks take about 3.5 years to return to near their prior peak.

The average of the past six recessions might be misleading since it includes the so-called "Great Recession" of 2008. The economic and market impact of the Great Recession was more akin to the Great Depression of the 1930s than a typical downturn. That was largely due to systemic vulnerabilities compounding the impact of the recession, which no longer appear to be as much of a problem. 

A better guide?
Removing the Great Recession data from our analysis may offer a better guide to what to expect as this current economic cycle nears a peak. The chart below offers this perspective, omitting the Great Recession of 2008.

Performance of MSCI World Index ahead of past 5 global recessions (excluding 2008)

Global recession graph

What can we expect when the current cycle finally peaks? Looking at the past five "typical" recessions and bear markets, on average:

  • The global recession lasts just under one year.
  • Stocks tend to fall for about a year and a half.
  • During the bear market, stocks tend to fall a little over 20% from peak-to-trough (although this varies widely as you can see in the shaded range of performance in the chart above).
  • Stocks tend to bottom about the same time the recession is ending (although recessions aren't usually declared over until many months, and sometimes years, have passed, the economic data reflects a pickup in activity).
  • It takes about 3.5 years to fully recover the losses.

It is interesting to note that the duration of the stock market decline and the length of time to recover the loss is the same whether 2008 is included in the average or not. The only difference including 2008 recession data makes is a deeper average decline.

Setting expectations
With global stocks down about 10% from this year's high, they may have already shed about half of the bear market losses if they continue to track the average late cycle path. Losses have tended to happen quickly while the recovery has tended to take longer to complete. It is important to remember that over a long-term time horizon, these recessions and bear markets look like temporary dips a rising path, as you can see in the chart below.

MSCI World Index total return since inception

MCI return graph

Setting expectations is important to avoid surprises that might cause an investor to abandon their long-term plan. While we think it may be a bit early for the stock market to be pricing in a recession, investors may want to consider underweighting the most volatile asset classes such as emerging market stocks. Those with time horizons beyond 3.5 years and a diversified portfolio may want to revisit their long-term plan and remind themselves that ups and downs are part of investing for the long term.