The three kinds of bear markets and how they recover

This article explains the three kinds of bear markets and how they recover. At the time of writing, the broad market had fallen roughly 21% from its peak this year. In our view, several forces drove the decline. First, the Federal Reserve adopted a hawkish monetary policy. In addition, inflation ran high as supply chains faltered and Russia invaded Ukraine.

A bear market typically means a fall of more than 20% from a peak. Given how sharply macro expectations shifted, we do not find a decline of this size very surprising. For example, twelve months ago the market expected no rate hikes this year and only a couple by the end of 2023. At the same time, growth expectations were rising with the post-pandemic recovery. Meanwhile, few investors foresaw the war between Russia and Ukraine.

Understanding the three kinds of bear markets and how they recover

Investors often view market declines as binary: you are either in a bear market or you are not. In practice, however, bear markets differ depending on their drivers. Analysts commonly group them into three broad types.

• Structural bear market. This type usually stems from structural imbalances or financial bubbles. For example, during the 2007 financial crisis the market fell 57% and took 49 months to recover.
• Event driven bear market. In contrast, this kind stems from specific, infrequent events that typically do not lead to a domestic recession. Examples include wars, emerging market crises and pandemics. The 34% drop between February and March 2020 is the latest example.
• Cyclical bear market. Finally, this type typically follows shifts in the economic cycle, a rising interest rate curve and higher inflation. The last one ran from July to October 1990, when the market fell 20% and took about four months to recover. The invasion of Ukraine has influenced the current correction. However, in our opinion it most closely resembles a cyclical bear market, and this view could prove wrong.

Why does the type matter? The driver of a decline often shapes how deep it runs and how long recovery takes. For instance, structural declines may take longer because imbalances need time to unwind. In contrast, event driven and cyclical declines have often been shorter, as the examples above show. Of course, no classification is perfect, and a single bear market can share features of more than one type.

What history says about the recovery

We understand that bear markets can feel unsettling. Historically, returns following declines close to 20% have averaged around 19%, 36% and 72% after one, three and five years, respectively. However, these are historical averages, and past performance does not guarantee future results. Individual periods varied widely, and some recoveries took far longer. In other words, studying the three kinds of bear markets and how they recover offers context, not a forecast.

Keeping perspective during volatility

In our view, staying focused on the plan you built at portfolio construction may help you participate in a recovery after intense volatility. Of course, a plan cannot remove risk, and markets may fall further first. We are not suggesting that short-term volatility has ended. Instead, we aim to show how long-term positioning can help investors pursue their goals. This article is educational and is not an individual recommendation. Therefore, please speak with your advisor about your own situation.

It can also help to review a few practical questions with your advisor. First, does your time horizon still match your goals? Next, does your current mix of investments still reflect your tolerance for risk? In addition, do you hold enough cash for near-term needs, so you are less likely to sell during a downturn? Finally, would rebalancing bring your portfolio back toward its target allocation?

Source for bear market and recovery history: Goldman Sachs. Figures are historical and illustrative only. Indexes are unmanaged, and investors cannot invest directly in them.