Specifically, I tested the hypothesis that a bear market’s severity is correlated with the overall market’s P/E ratio at the start of that bear market. Somewhat more promising is the price/earnings ratio. Other tests of this hypothesis reached similar results. Following the 50% of bull markets that were the longest, in contrast, the Dow lost a nearly identical average of 30.8%. Consider first those bear markets that followed the 50% of bull markets that were the shortest: In those bear markets, the Dow fell by an average 31.5%. market history.įortunately, there is no correlation between bull-market length and subsequent bear-market severity, as you can see from the chart below. Some have worried that this might be the case, since many assume that the current bull market is the longest in U.S. The first hypothesis I tested is that a bear market’s severity is a function of the prior bull market’s length. stock investors have experienced a total of 36 bear markets since then, by their count. Here’s what history shows about past bear markets hitting new lows from there.To find out whether a bear market’s severity can be forecasted, I analyzed all bear markets since 1900 (according to a bear market calendar maintained by Ned Davis Research, the quantitative research firm). recession arriving in 2023 or 2024Īlso read: S&P 500 sees its third leg down of more than 10%. He can be reached at Ray Dalio says stocks, bonds have further to fall, sees U.S.
His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. Mark Hulbert is a regular contributor to MarketWatch. The point of this discussion is that higher interest rates are not an additional reason, above and beyond the other factors affecting the stock market, why the market should fall. Indeed, by many measures, stocks are still overvalued, despite the much cheaper prices wrought by the bear market. None of this means that the bear market shouldn’t continue, or that equities aren’t overvalued. Investors were guilty of inflation illusion when they reacted to the Fed’s latest interest rate announcement by selling stocks. While earnings tend to grow faster when inflation is higher, they must be more heavily discounted when calculating their present value. Failing to appreciate this other half of the story is a fundamental mistake in economics known as “inflation illusion” - confusing nominal with real, or inflation-adjusted, values.Īccording to research conducted by Warr, inflation’s impact on nominal earnings and the discount rate largely cancel each other out over time. The other half of this story is that interest rates tend to be higher when inflation is higher, and average nominal earnings tend to grow faster in higher-inflation environments.
While that argument is not wrong, Richard Warr, a finance professor at North Carolina State University, told me, it’s only half the story. That wisdom is based on the eminently plausible argument that higher interest rates mean that future years’ corporate earnings must be discounted at a higher rate when calculating their present value. These results are so surprising that it’s important to explore why the conventional wisdom is wrong. In other words, the ability to predict the stock market’s five- and 10-year returns goes down when taking interest rates into account. Predictive power of the difference between the stock market’s earnings yield and the 10-year Treasury yield Predictive power of the stock market’s earnings yield When predicting the stock market’s real total return over the subsequent… stock market back to 1871, courtesy of data provided by Yale University’s finance professor Robert Shiller.
#Mark hulbert market watch series#
The table reports a statistic known as the r-squared, which reflects the degree to which one data series (in this case, the earnings yield or the Fed Model) predicts changes in a second series (in this case, the stock market’s subsequent inflation-adjusted real return). It is not, as you can see from the table below. If higher interest rates were always bad for stocks, then the Fed Model’s track record would be superior to that of the earnings yield. This margin sometimes is referred to as the “Fed Model.” The margin between the stock market’s earnings yield and the 10-year Treasury yield The stock market’s earnings yield, which is the inverse of the price/earnings ratio To show why higher interest rates aren’t necessarily bad for equities, I compared the predictive power of the following two valuation indicators:
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