Bear Market Threshold
"Dow
falls 166.75 to Bear-Market Level"
--WSJ July 3, 2008
Back
in 2008, the July 2 market drop nearly brought the DJIA
decline below its 20% “bear market” threshold.
The S&P was off 19.40%, within less than a single day’s normal
fluctuation of also reaching a 20% loss.
No economic logic underlies the
widespread belief that a bear market begins only after a 20% market drop.
It is arbitrary and much too “neat” to be analytically credible.
It is also so retrospective as to let nearly half a trend escape before
detection. I have disdained the
20% mantra for years.(*)
But the fact is, we find empirical evidence that crossing the 20%
threshold may actually have some forward-looking import.
There have been five occasions of 20% decline over the past 40 years.
In every case the market continued downward. The ensuing
decline (after 20% loss) was greater than would be expected by chance. On
four of the five occasions,
ensuing decline was far greater than could be expected by chance.
S&P 500 Crossing the Bar
|
Bear
Market |
Total
Pct Decline(** |
Decline
up to 20% Bear Threshold |
Still-to-go after
-20% |
|
2007-09 |
-56.8% |
-20% |
-46.0% |
|
1987-87 |
-33.5% |
-20% |
-16.9% |
|
1980-82 |
-27.1% |
-20% |
-
8.9% |
|
1973-74 |
-48.2% |
-20% |
-35.3% |
(**) Total decline is less than sum of parts due to downward compounding; e.g.
top line (1 - .568)/(1 - .20) = (1 - .460).
The findings in the “still-to-go”
column are astonishingly improbable, but real. Consider this; of all declines from any S&P high,
87% are smaller than -5%, and 94% are
smaller than 9% (which is the smallest follow-through above, in
1980-82).
That implies 15-to-1 odds against a -9% drop from a new high But
after passing the -20% mark, the average additional loss was -28.7%.