What We Can Glean From Previous Bear Markets

We chose three different metrics to evaluate previous bears: the length of time to reach a bottom, the depth of the drawdown, and starting vs. bottom valuations. 

For our valuation measurement, we chose to use the CAPE ratio because trailing 12-month earnings are highly volatile during recessions, thus skewing the P/E ratio. Using forward earnings estimates has historically had the highest error rate both going into and coming out of recessions. The benefit of the CAPE is that it uses 10 years of earnings, which helps mitigate any short-term earnings noise and provides a more persistent/stable earnings measure. 

Of the eight bear markets accompanied by a recession in the S&P 500 Index since 1956, the average CAPE ratio at the bottom of the sell-off was about 15x (FIGURES 1 and 2). We analyzed the bottom CAPEs relative to their historical CAPEs (FIGURE 1). From this perspective, bears historically have hit bottom when stocks reached about bottom-quartile cheapness and the multiple compressed by 35% on average.
 

Most Attractive Equity Styles Today

Given the broad market sell-off, we thought it might be useful to look deeper into styles. In FIGURE 3, we can see that US small-cap value and US small-cap growth are below their bear-market bottom P/Es (black dashed lines). Yet even with 2022’s pullback, US large-cap growth remains historically expensive: its P/E multiple would need to compress another 23% to reach its average bear-market bottom.   

In international markets, we observed a similar trend from a large-cap perspective: Value is currently attractively priced while growth remains historically expensive (red circles in FIGURE 4). Contrary to US markets, however, broad international equities continue to be priced at an attractive level, both historically and within a bear-market context.  

A final key observation is that bottom-quartile cheapness seems to be the historical inflection point for previous bear markets both at home and abroad: All US and international equity styles’ average bear-market bottom P/Es (black dashed lines) are around the 25th percentile (FIGURES 3 and 4).

Which Asset Classes/Styles Perform Best Coming Out of a Bear Market?

Based on the average duration, total price decline, and ending valuation of previous bear markets, we don’t think we’re quite out of the woods yet. 

Rather than trying to guess when we’ll reach the official end, investors who are ready to prepare for the next bull market now may want to focus on styles with more cyclicality that can benefit from economic recovery. FIGURE 5 shows various asset-class returns one year after the market reached its bear-market bottom.