{"id":67963,"date":"2017-12-14T00:26:22","date_gmt":"2017-12-13T23:26:22","guid":{"rendered":"http:\/\/beta.next-finance.net\/opinion\/are-we-heading-for-a-bear-market\/"},"modified":"2020-01-01T22:10:54","modified_gmt":"2020-01-01T21:10:54","slug":"are-we-heading-for-a-bear-market","status":"publish","type":"post","link":"http:\/\/beta.next-finance.net\/en\/opinion\/are-we-heading-for-a-bear-market\/","title":{"rendered":"Are we heading for a bear market?"},"content":{"rendered":"

The S&P 500 has closed at a fresh all-time high 57 times so far this year, while the Nasdaq
\nhas secured 70 new all-time high closes, shattering the 1999 record of 61. The fact that the
\n1999 rally was followed by a crash is making many people nervous, Daalder says.<\/p>\n

Trying to see one coming though is not an exact science, as economists and academics
\ncannot even agree on what constitutes a bear market, and not all stocks have become
\nexpensive due to the continuing bull market, he says.<\/p>\n

\u201cConcerns of an upcoming correction are spreading with each all-time high reached,\u201d says
\nDaalder, whose multi-asset fund remains overweight on stocks. \u201cReading through the
\nvarious outlooks published by the major banks and institutions, the central theme is one of
\ncautious optimism, with a clear emphasis on the caution part.\u201d<\/p>\n

Lofty levels<\/strong><\/p>\n

\u201cThe valuation of US stocks has reached lofty levels, while credit spreads have declined,
\nregardless of the underlying deterioration of credit quality and overall leverage. Not surprisingly, more and more analysts are contemplating if, when and how the current rally
\nin the risky parts of the US financial markets will come to an end.\u201d<\/p>\n

A recent Financial Stability Review by the European Central Bank flagged the high valuation
\nof the US stock market, warning that any correction there would also pose a risk for the much
\ncheaper European stock markets. But would it trigger a bear market?<\/quote><\/p>\n

\u201cIf you want to take a crack at predicting bear markets, you first need to have a clear idea of
\nhow to define one,\u201d Daalder says. \u201cUsing one definition of \u2018any 20% correction from the
\nprevious peak\u2019 sounds simple, but it raises a number of questions.\u201d<\/p>\n

\u201cStrictly interpreted, this means that the Nikkei index has been in a bear market for over 27
\nyears. Although no one will claim that the Nikkei has been a solid investment, it does not do
\njustice to the six 20%+ drawdowns that the index has experienced since the 1990s.\u201d<\/p>\n

\u201cAnother consideration may be that of inflation: the Brazilian Bovespa rose more than
\n1,000% in 1994, while inflation was as high as 5,000%. Most investors would qualify that as
\na bear market.\u201d<\/p>\n

Shiller’s definition<\/strong><\/p>\n

Daalder looks at the definition of the Nobel Prize-winning economist Robert Shiller: \u201cThe
\npeak before a bear market, per my definition, was the most recent 12-month high, and there
\nshould be some month in the subsequent year that is 20% lower.\u201d This means there have
\nbeen 13 US bear markets since 1881 \u2013 the most recent one occurring during the Eurozone
\ncrisis of 2011 \u2013 but it still doesn\u2019t tell the whole story, Daalder warns.<\/p>\n

\"les_13_phases_baissieres_aux_etats-unis_identifiees_par_shiller._source_-_shiller-robeco.png-2.jpg\"<\/a><\/p>\n

\u201cThe rule that a 20% correction needs to take place within 12 months means that you are
\nfiltering out the bear markets that take a bit longer to develop,\u201d he says. \u201cAdditionally,
\nwhereas Shiller uses real prices in the construction of his famous Cyclical Adjusted Price
\nEarnings ratio (CAPE, or Shiller PE), he sticks to a nominal approach. As a result, the 1970s
\nand 1980s were \u2018bear-free\u2019, even though there were some pretty nasty corrections during
\nthat timeframe.\u201d<\/p>\n

Considering volatility<\/strong><\/p>\n

The fact that high valuation increases the risk of a correction is probably not a shocking
\nstatement to make, but does low volatility add something to the mix as an early warning
\nsignal? Shiller seems to imply so by warning that in his US analysis, \u201cstock price volatility was
\nlower than average in the year leading up to the peak month preceding the 13 previous US
\nbear markets\u201d. This has led some investors to draw parallels with today\u2019s low levels of
\nvolatility as a danger signal.<\/p>\n

However, this is also unreliable, Daalder says.
\n\u201cRecord low volatility is by no means a reliable
\nearly warning signal for spotting bear markets. Looking at the top-10 list of periods of record
\nlow volatility, only once (in 1895) did it precede a bear market: in the other nine cases there
\nwas no bear market sell-off. All in all, on a standalone basis, this does not appear to be a
\nuseful tool with which to flag a bear market.\u201d<\/quote><\/p>\n

So what about looking at the combination of valuation and volatility? The table below
\nattempts to do this by matching volatility levels with 12-month forward stock market returns.
\n\u201cIf the combination of low volatility and high valuations have historically spelt trouble, one
\nwould expect the returns of the bottom left of the table to be lower on average than in the
\nrest of the table (inside the red circle). But there does not appear to be a particular low point
\nin that part of the matrix,\u201d Daalder says.<\/p>\n

\"matrice_volatilite-valorisation_pour_les_rendements_sur_12_mois._source_-_shiller-robeco2-2.jpg\"
\n\u201cAll in all, we do not think that there is much predictive value to be had by looking at the
\ncombination of valuation and volatility. Of course, we agree with the ECB and Shiller that the
\ncurrent valuation of US stocks is a cause for concern, but whether that means that we are
\nheading for a correction anytime soon remains to be seen.\u201d<\/p>\n

\u201cThe current rally has been very much momentum and liquidity driven, and so far we see
\nlittle signs that this is about to end. We therefore continue to be long on stocks, but with a
\ntight stop loss in place.\u201d