Goldman: A Bear Market Is Coming And Here’s How To Avoid Losing 25%

On Wednesday evening we noted that this is now the third strongest bull market in history on the S&P.

As Bloomberg’s Lu Wang writes, “the S&P is sitting a hefty 269 percent higher than its March 2009 nadir, surpassing the 266 percent advance notched during the 1949 to 1956 bull market.” Here’s the visual on that:

That’s just the latest reminder of how precarious (or “durable” depending on whether you’re a “glass half full” or a “glass half empty” type of person) the situation has become for a market that hasn’t seen even a 3% pullback in 10 months:

“A typical pullback in the S&P 500 is long overdue [as] historically, 3-5% selloffs in the S&P 500 have occurred on average every 2-3 months,” Deutsche Bank wrote a couple of weeks ago, adding that “the current rally has now gone 10 months without a 3% sell-off, making it the 3rd longest since World War II without one.”

In this context, Goldman is out with a sweeping new note aptly entitled “the bear necessities,” which takes a look at the current bull run and provides a useful review of historical precedent for what you can expect when things finally turn. Here’s the bank’s take on where we stand currently:

If we take the S&P 500 as a benchmark (given that it has been the strongest of the markets and we have the longest history), the current bull market is closing in on the longest in the post-war period. If we ignore the 2011 correction of 19% in the US (a bear market in Europe but technically just falling short of one in the US), we have now seen 102 months of bull market; the longest occurred from 1990 and lasted 115 months. If we define the 2011 downturn as a fully fledged bear market, this would make the current bull market 72 months in duration — more in line with the average.

But as Exhibit 7 shows, it has not only been among the longest but is also the second-strongest equity bull market in history.

Goldman goes on to remind you that we are stretched to the proverbial breaking point, something you hopefully already know, even if you think this rubber band isn’t set to snap just yet:

Goldman does note that equities still look cheap relative to bonds, but that gets us back to the question of whether bonds are effectively serving as a crutch for stocks – that is, by becoming more expensive still, bonds are allowing equity multiples to expand inexorably.

Next, the bank provides you with a table that lists the “characteristics of a bear market” (in case you were fuzzy on that):

And then there’s a fun list of historical bear markets since the 1800s:

Oh, and Goldman wants you to know that despite what you may have heard from the former Target logistics manager down the street who you let invest your entire life savings in short VIX ETPs, “this is just a matter of when”. To wit:

Bear markets are inevitable: the question is not if, but rather when, the next one will occur. The problem is that, while bear markets are very obvious with the benefit of hindsight, they are very difficult to identify in real time. Many corrections turn out to be short-lived and relatively benign, and it is difficult to know in the middle of a correction if it will be short-lived or turn into a full bear market. Some factors tend to lead bear markets but they also have a tendency to provide false signals at other times. Some are more reliable but can reach worrying levels a year or more before a bear market.

[Aside: you’ve gotta love how they say “bear markets are very obvious with the benefit of hindsight” – I mean, that’s certainly true, but it’s like saying “that 3% move lower in XYZ yesterday is obvious to me today.”]

The good news is, you don’t have to actually call the top, because as it turns out, “identifying the exact peak of a bull market is less important than recognising a bear market once it starts”:

Selling after the first 3 months of the market peak would, on average, put an investor in the same position as one who sold equities 3 months before the peak.

There is nearly always a bounce after the initial decline in a bear market that provides investors with another opportunity to reduce risks.

The bank’s hilariously deadpan (and self-evident) conclusion:

The key is to avoid the next 20-25% of declines that typically follow the initial period of volatility.

Yes, “the key” is to avoid seeing a quarter of your portfolio disappear into thin air.

Of course that assumes you actually have a “portfolio” and aren’t just sitting on an E*Trade account full of XIV, in which case the nominally small VIX spike that would almost invariably accompany the average 6% decline on the S&P that occurs during the first three months of the downturn would wipe you (and your neighbors) out in a matter of hours.