Keep the Faith in This Bear Market

Dustin Hall |

1. Just how bad has this year been?

There’s no way to sugarcoat things—2022 has been a rough year. Bonds historically have done well when stocks don’t, but this year that isn’t happening. In fact, the five previous times the S&P 500 lost 10% or more for the year, bonds (as measured by the Bloomberg U.S. Aggregate Bond Index) gained every time, up 7.7% on average.

So far in 2022, it’s been quite a bit different. With the S&P 500 price index down 25.3% year-to-date and bonds down 14.6% through Q3’22 (measured by the Bloomberg U.S. Aggregate Bond index—largely U.S. Treasuries and highly rated corporate bonds), only 2008 was a worse year for a 60/40 portfolio (one with 60% in stocks and 40% in bonds). The Chicago Board of Options Exchange (CBOE) Volatility Index (VIX), also known as Wall Street’s fear gauge, climbed from 16.6 at year open to 32.02 at close of October 14, indicating significant volatility and uncertainty in the market.

2. If it is so bad, why shouldn’t I just sell everything right now?

The current Federal Reserve rate hiking cycle isn’t helping short-term performance, as the Fed raises rates aggressively to stem persistent inflation. It’s not all bad news—across the last nine U.S. Fed hiking cycles (1972–2015), the S&P 500 has returned an average of 8%. And, though performance over these times has been a mixed bag, stocks historically perform well after a bear market, regardless of recession (see Figure 1). Indeed, stocks are typically up an average of 19.5% one year from post-bear market entry (from 1950–2022, the S&P 500 was up an average of 13% during recessionary bear markets and 29.8% during non-recessionary bear markets). The combination of a bear market and midterm season is certainly turbulent, but there’s a light at the end of the tunnel for those who hold on.

The longer the investment period, the higher the frequency of an S&P 500 rolling period with a positive return. Holding the S&P over a one-month period has a positive return 64% of the time, compared to an 81% chance of a positive return holding over one year and 95% over 10 years. When timing the market, early is on time and on-time is late, so the best option is to ride out the turbulence.

3. Do the midterm elections have anything to do with this?

Stocks historically haven’t done very well in the first few quarters of a midterm year, but they do quite well once the midterm election is over (see Figure 2). In fact, according to Ryan Detrick of Carson Group, since World War II, the S&P 500 has been higher a year after the midterm election every single time, up 14.1% on average. Much better times could be coming within a year.

One final reason to remain optimistic and not sell now is that data show stocks have historically tended to perform well after a midterm year low (see Figure 3). Since 1950, the S&P 500 has gained more than 32% on average off the lows and has never been lower a year later. The June lows are not far away from current levels. Should new lows be made, it could be another positive for investors going out a year or more.

In midterm season, Q3 of year two in a presidential cycle (aka, Q3’22) has returned an average of just 0.5% from 1950 to present (see Figure 4). Thankfully, this soft time is traditionally followed by stronger returns: the next three quarters of the cycle (which in today’s case would be Q4’22, Q1’23 and Q2’23) have historically returned 8.6%, 7.4% and 4.8%.

So there you have it, yet another clue that stocks potentially could be a good deal higher this time next year. Nonetheless, the market will likely remain volatile until the data suggests (and the Federal Reserve believes) that inflation is under control.

4. Investing with recession risk

A recession is an opportunity to go shopping—prices are cheaper than they’ve been in recent memory. Goldman Sachs Investment Strategy Group advises that when considering whether to underweight stocks, investors should consider recession risk, when the recession started, and current drawdown level (see Figure 5).

Regardless of imminent recession risk, large equity drawdowns, like the one the market is currently experiencing, serve as good times to stay invested and potentially overweight stocks. In the case of small equity drawdowns, advice is more variable: when there is low imminent recession risk, staying invested is likely the best move, but in the case of a small equity drawdown and high imminent recession right, it might be the time to potentially underweight some stocks.

The current drawdown is also important: should recession hit, bear markets are down 34.8% on average and last an average of 15.2 months. The S&P 500 was down 24.8% YTD at the close of Q3, and GDP declined at an annualized rate of 1.6% and 0.9% during Q1’22 and Q2’22 (though a recession won’t be official until the National Bureau of Economic Research conducts its post-ante analysis). Assuming we are in a recession, the S&P 500 has another 10% to fall to reach historical averages, so though the current drawdown might not be the market bottom, the majority of the drop is likely over, and it presents a strong buying opportunity (or at least a reason to stay invested) nonetheless.

Though times of market turbulence are scary, we must remind ourselves that the worst thing to do is panic and withdraw from the markets. Alternatively, there are other ways to take advantage of the market downturn, like making IRA contributions, adding more money, and rebalancing portfolios. 


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The Bloomberg Barclays U.S. Aggregate Bond Index is an index of the U.S. investment-grade fixed-rate bond market, including both government and corporate bonds.”

Original source: Horsesmouth