Last year proved to be one of the most challenging in history for investors. When we officially turned the page, the ageless Dow Jones Industrial Average (^DJI 0.03%)widely followed S&P 500 (^GSPC -0.02%)and dependent on technology Nasdaq Composite (^IXIC) fell by 9%, 19% and 33% respectively. All three indexes spent at least part of 2022 in a bear market.
However, the new year brings new hope that brighter days are ahead for Wall Street. Unfortunately, history and hope are at odds with each other.
Most stock market corrections resolve in less than a year
Although you may not realize it, stock market corrections — declines of at least 10% from a recent high — are quite common. Since the early 1950s, the S&P 500 has experienced 39 separate corrections, according to data from the sell-side consulting firm Yardeni Research.
Most of these declines do not take long to find their respective bottoms. Not including the 2022 bear market, 24 of the previous 38 corrections since 1950 reached their lows in 104 or fewer calendar days (about 3 1/2 months). Another seven corrections took between 157 calendar days and 288 calendar days to resolve. In other words, in all but seven corrections over a 73-year period, stock market declines took more than 10 months to bottom out.
As of the close of the bell on Jan. 4, 2023, the S&P 500 had spent 282 calendar days in a bear market, according to Yardeni. We are just a few days away from entering diluted territory in terms of the length of the existing decline.
If there’s a positive here, it’s that the length of the stock market correction doesn’t correlate with the size of the decline. Four of the 10 longest corrections in the S&P 500 since 1950 resulted in peak declines ranging from just 14% to 19%.
However, the existing bear market does not appear to be near the bottom.
This could become the longest bear market in history
There is no doubt that the Federal Reserve and investors (both tenured and new) are navigating uncharted waters. At no time in the history of our nation’s central bank has it had to aggressively raise interest rates while the stock market is crashing. But with the U.S. inflation rate hitting a four-decade high of 9.1 percent in June, taming the pace of price increases has become paramount.
While the Federal Reserve’s monetary policy isn’t particularly helpful in determining when a stock market correction will occur or how sharp the decline will be, it can be quite useful in deciphering when the stock market will bottom out and reverse course.
Since the beginning of this century, the Fed has undertaken three cycles of interest rate easing (ie, the nation’s central bank lowered interest rates). In each of these cases, the benchmark S&P 500 took a long time to find its footing.
- January 3, 2001: During the dotcom bubble, the nation’s central bank cut the federal funds rate from 6.5% to 1.75% in less than a year. However, it took 645 calendar days after that initial rate cut for the S&P 500 to hit its low.
- September 18, 2007: The financial crisis forced the Federal Reserve to cut its federal funds rate from 5.25% to a range of 0% to 0.25%. But the S&P 500 didn’t bottom until 538 calendar days after the first rate cut.
- July 31, 2019: The third easing cycle this century saw the Federal Reserve cut its funds rate from a range of 2% to 2.25% to 0% to 0.25%. The S&P 500 bottomed out during the coronavirus crash in March 2020 – 236 calendar days after the first rate cut.
On average, it has taken 473 calendar days (about 15 1/2 months) this century for the broad-based S&P 500 to bottom out after the central bank begins a cycle of easing interest rates.
Here’s the problem: The Federal Reserve is nowhere near an easing cycle. According to the Fed’s December 2022 “Summary of Economic Projections” (also known as the “dot plot”), interest rate easing is not expected until sometime in 2024. If so, the S&P 500 sticks to its average for this century timeline for finding a bottom, we are talking about a bear market that could easily exceed more than 1000 calendar days and become the longest in history. To date, the longest bear market occurred between 2000 and 2002 and lasted 929 calendar days.
Three smart ways to invest during prolonged bear markets
While that’s probably not the projection you want to hear, it doesn’t have to be terrible news either. Historically, bear markets have been an excellent time to invest and have allowed investors to buy time-tested businesses at significant discounts.
One of the smartest moves investors can make during a prolonged bear market is to buy dividend stocks. Publicly traded companies that pay dividends tend to be profitable on a recurring basis and have successfully weathered past economic downturns. What’s more, dividend stocks have outperformed non-paying ones by a significant amount over long periods. In short, they are just the type of business you should want to own when uncertainty prevails.
Investing in defense sectors and industries can also be a genius move. For example, utility companies are a solid bet to outperform during a bear market because of their highly predictable cash flow. Homeowners and renters don’t change much in their electricity consumption habits from year to year. In addition, most electricity companies operate as monopolies or duopolies, leaving little choice for consumers.
A third smart move during prolonged bear markets is to consider buying exchange-traded funds (ETFs). Buying an ETF allows investors to instantly diversify or concentrate their investments with the click of a button. With ETFs for nearly every sector, industry, trend, region and market capitalization, investors have plenty of ways to put their money to work for the long term without necessarily worrying about individual stock risk.
The key point here is that staying invested, even during a potentially prolonged bear market, is a wise decision for long-term investors.