When a correction becomes a bear – and what to do about it

04 February 2016 | Markets and economy


When does a correction turn into a bear market? There's no universal rule, but there is a rule of thumb.

By convention, a correction is generally defined as a decline of 10% or more in the value of a benchmark index such as the Hang Seng, the FTSE Straits Times Index or the Nikkei 225. The term bear market typically refers to a decline of 20% or more lasting at least two months.

From their high on 21 May 2015 through 20 January 2016, global equity prices lost about 19% of their value. That qualifies as a correction, certainly. Whether it's viewed as a bear market won't be known for a few more weeks, at least.

Corrections are commonplace

Historically speaking, stock market downturns – both corrections and bear markets – are relatively common events.

Since 1980, the global equity market* has experienced 12 corrections and seven bear markets. That works out to an attention-grabbing downturn roughly every two years, on average. Add together all the corrections and bear markets since 1980, and you find that share prices spent almost 30% of all trading days in the midst of a sharp downturn. (This considers daily price returns only. If you're doing what's known as a total return analysis, where reinvested dividends are factored in, returns would be higher and recoveries quicker.)

A similar story emerges from an analysis of the US stock market's more extensive historical data.

Since 1928, the S&P 500 Index, which represents 500 of the largest companies in the United States, has been in a correction or bear market roughly 40% of the time. Cumulatively, that would work out to a market slump lasting about 35 years. But experienced investors know that the long-term performance of the US market during this period has been anything but grim. Indeed, the S&P 500 has produced an average annualised return of about 10%, outperforming lower-risk assets such as bonds and cash.**

Here's one way to put those occasional – and occasionally severe – setbacks in perspective: They were the price equity investors paid to realise long-term returns superior to those of lower-risk assets.

Depth and duration have varied

Some corrections are swift and dramatic. Others are slow and gradual. Similarly, the length of time from a market's low point (its "trough") to full recovery has been similarly unpredictable. Consider a few observations from the global stock market data:

  • The average number of days from the start of a correction to its trough was 87. The fastest decline was 28 days, while the slowest was 124.
  • The average time from a correction's trough to recovery was 121 days. The fastest rally was 46 days, the slowest 359.

Bear markets have generally taken longer to reach bottom and longer to recover:

  • The average time from the start of a bear market to its bottom was 373 days. The fastest decline was 60 days; the slowest was 926.
  • The average time from a bear market trough to recovery was 798 days. The fastest recovery was 85 days, the slowest 1,928.

Global stock prices (1 January 1980–22 January 2016)

  Number Average return Average time from peak to trough Average time from trough to recovery
Correction 12 -13.7% 87 days 121 days
Bear market 7 -33.4% 373 days 798 days

Note: Vanguard analysis based on the MSCI World Index from 1 January 1980 through 31 December 1987 and the MSCI All Country World Index thereafter. Both indices are denominated in US dollars. Our count of corrections excludes corrections that turned into a bear market. We count corrections that occur after a bear market has recovered from its trough even if stock prices haven't yet reached their previous peak.

Surprising, and yet inevitable

The boldface headlines announcing each market downturn always make the turmoil seem shocking.

To be sure, every correction or bear market involves some sort of surprise catalyst that disturbs the status quo. However, such setbacks are inevitable. We expect equity shares to produce higher long-term returns than bonds and cash precisely because they experience occasional downturns. Therefore, Vanguard believes that patience and discipline are the best responses to market turmoil.

Our economic and investment outlook for 2016 underscores the potential benefits of keeping a long-term perspective. Our analysis includes a range of projected outcomes for each asset class in the coming decade:

  • We expect average annual global equity market returns to be centred in the 7% to 9% range.
  • We expect average annual global fixed income returns to fall in the 1.5%-2.5% range. As our report explains, these muted expectations reflect an era of low interest rates and low inflation.

Vanguard's probabilistic forecasts acknowledge that the actual outcomes may be different, of course, but investors have historically earned a risk premium for holding equities through the inevitable setbacks. A balance between equities and lower-risk assets such as bonds and cash can help moderate the impact of corrections and bear markets on a diversified portfolio.

*As represented by the MSCI World Index from 1 January 1980 through 31 December 1987 and the MSCI AC World Index thereafter.
**Average annualised returns, 1 January 1928 – 31 December 2015: US shares = 9.72%; US bonds = 5.41%; cash = 3.49%. Shares are represented by S&P 500 Index. Bonds are represented by Standard & Poor's High Grade Corporate Index from 1926 to 1968, the Citigroup High Grade Index from 1969 to 1972, the Lehman U.S. Long Credit Aa Index from 1973 to 1975 and the Barclays Capital U.S. Aggregate Bond Index thereafter. Cash is represented by US Treasury bills.

Important information:

The contents of this document and any attachments/links contained in this document are for general information only and are not advice. The information does not take into account your specific investment objectives, financial situation and individual needs and is not designed as a substitute for professional advice. You should seek independent professional advice regarding the suitability of an investment product, taking into account your specific investment objectives, financial situation and individual needs before making an investment.

The contents of this document and any attachments/links contained in this document have been prepared in good faith. The Vanguard Group, Inc., and all of its subsidiaries and affiliates (collectively, the "Vanguard Entities") accept no liability for any errors or omissions. Please note that the information may also have become outdated since its publication. The Vanguard Entities make no representation that such information is accurate, reliable or complete. In particular, any information sourced from third parties is not necessarily endorsed by the Vanguard Entities, and the Vanguard Entities have not checked the accuracy or completeness of such third party information.

This document contains links to materials which may have been prepared in the United States and which may have been commissioned by the Vanguard Entities. They are for your information and reference only and they may not represent our views. The materials may include incidental references to products issued by the Vanguard Entities. The information contained in this document does not constitute an offer or solicitation and may not be treated as an offer or solicitation in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The Vanguard Entities may be unable to facilitate investment for you in any products which may be offered by The Vanguard Group, Inc. No part of this article or any attachments/links contained in this article may be reproduced in any form, or referred to in any other publication, without express written consent from the Vanguard Entities. Any attachments and any information in the links contained in this article may not be detached from this article and/or be separately made available for distribution.

This document is being made available in Hong Kong by Vanguard Investments Hong Kong Limited (CE No. : AYT820) ("Vanguard Hong Kong"). Vanguard Hong Kong is licensed with the Securities and Futures Commission to carry on Type 1 – Dealing in Securities, Type 4 – Advising on Securities and Type 9 – Asset Management regulated activities, as defined under the Securities and Futures Ordinance of Hong Kong (Cap. 571). The contents of this document have not been reviewed by the Securities and Futures Commission in Hong Kong.

In China, the information contained in this document does not constitute a public offer of any investment products in the People's Republic of China (the "PRC"). No Vanguard fund is being offered or sold directly or indirectly in the PRC to the PRC public. Further, no legal or natural persons of the PRC may directly or indirectly purchase any of Vanguard funds or any beneficial interest therein without obtaining all prior governmental approvals that are required by the PRC (which includes conducting due approval or registration or filing formalities under the PRC laws), whether statutorily or otherwise. Persons who come into possession of this document are required by the issuer to observe these restrictions.

In Taiwan, Vanguard funds are not registered and may not be sold, issued or offered. No person or entity in Taiwan has been authorised to offer, sell, give advice regarding or otherwise intermediate the offering and sale of any Vanguard funds in Taiwan.