How Long Are Bear Markets?

When the market is down, our mantra is time eats volatility.  We are very confident in the maxim because of the mathematics of volatility, but it’s important to understand how much time.

S&P 500 Bear Markets

To answer this question, we examine the monthly total returns of the S&P 500 since June 1927 through May of 2022 provided by Dimensional Fund Advisors. Specifically, we’ll examine the number of months in which the value was more than 20% below a prior value.  The returns included dividends.

The table below shows the continuous months experiencing a 20% or more drop from any prior value.  There were 18 periods of one or more continuous months.  The average was about 14 months, and the median (not shown) was a little under 4 months.  The longest period was 6 ½ years.  In total, there were 250 months in bear land.

The following graph shows these periods in red.  The graph plots a hypothetical initial $1 investment in the S&P 500 in June of 1927.  One can see that the bear markets after 1943 generally have been much shorter than before 1944.

S&P 500 and Bond Blend Bear Markets

While the news loves to focus on the stock market, investors often hold diversified portfolios, including bonds, which can mitigate volatility.  A portfolio with 60% S&P 500 and 40% 5-year Treasury bonds suffers fewer losses of 20% or more, and those bear market periods tend to be shorter.

The table below shows data for this type of blended portfolio.  Six periods had one or more continuous months with a 20% or more decline versus 18 for the S&P 500 portfolio.  The average period lasted under 13 months versus 14 months, respectively, and the longest lasted 58 months rather than 78 months.  The median was 4 months, which was about the same as the S&P 500.  The total number of months was 76, a 70% reduction from the S&P 500 portfolio.

The next chart shows the value of this blended portfolio since 1927.  The chart makes clear that after 1943, 20% losses in this portfolio were quite rare and short.

We conclude from this example that investors with a 60/40 blend can expect and prepare to endure bear markets lasting a year or longer.

Optimized Portfolio Bear Markets

Next, we take the blend one step further and add some optimization by replacing the S&P 500 with a Small-Cap Value Index, as calculated by Dimensional Fund Advisors.  However, we design this new blend so that the total return between 6/30/1927 and 5/31/2022 is equal to the S&P 500/bond blend rate of 6.8%.  In other words, the final value of both portfolios is $2,334.  The new blend consists of 32.5% small-cap value index and 67.5% bonds.

Looking at the historical data, six periods occurred with one or more continuous months, just like the 60/40 blend.  The average period lasted a little over 4 months with the longest lasting 13 months.  The median was under 3 months and there were none after 1938.  The total was 26 months, which represents a 66% reduction from the 60/40 blend and a 90% reduction from the S&P 500 alone.

Conclusion

The key takeaway is that bear markets can last years.  The average S&P 500 bear market lasted about 14 months, and the longest lasted over 6 years.

However, utilizing a diversified portfolio can significantly alter the outcome.  A 60/40 blend reduced the number of contiguous bear market periods by 67%, and the number of bear months by 70%.  The portfolio blend reduced the average period length by about a month as well.

Furthermore, an optimized portfolio with identical average returns to the 60/40 blend produced substantially better behavior.  The optimized blend of small-cap value with intermediate-term government bonds reduced the average length of bear market periods by 66% compared to the 60/40 blend.  And the total number of bear months went down 66% compared to the 60/40 blend, and 90% compared to the S&P 500.

Of course, past performance does not guarantee future results.  The optimized blend will underperform the unoptimized blend sometimes, and perhaps for very long periods.  At the same time, history is best source of data available, and an optimized portfolio selection may tilt the odds in the investor’s favor substantially.