by Denise Chisholm, Director of Quantitative Market Strategy, Fidelity Investments
Down nearly 20% on a closing basis, we’re bear market adjacent. Last week I shared some stats about bear markets – how common they are, the historical relationship between the speed of the decline and future returns, and why its important to extend your time horizon. Today, I’m following up with a few more observations. While we’re all waiting for earnings season to give us some clues, the truth is that stocks usually anticipate earnings weakness before the numbers come in.
Based on the relationship between three month returns in stocks and the change in earnings expectations, the market’s recent drop has already “priced in” nearly a 15% decline in earnings growth. Thinking about earnings as the next “shoe to drop” might be counterproductive. If you really are a long-term investor, you might be even less focused on this quarter’s earnings and guidance. Historically, once you’ve entered bear market territory, you’ve only been down once three years later. That doesn’t mean it can’t happen again, but it’s the exception, not the rule. Many times, you get paid not to react.
It’s tempting to blame bear markets on valuations. But if you plot starting historical PEs against the size of the eventual decline, you won’t find a relationship. Sure, you can cherry-pick examples to fit a story – but the data doesn’t support the idea that expensive stocks fell further. The unfortunate truth? It’s the ultimate decline in earnings that matter. The strongest link we can find is between the depth of the bear market and how much earnings decline. The bigger the eventual contraction in earnings growth, the bigger the drawdown.
This is exactly what makes things tricky. Because – again - stocks move before earnings do. And a 20% decline, historically, often implies a 15% drop in earnings growth. And that’s exactly where most historical examples are clustered. The data doesn’t give us certainty – it gives us probabilities. Most bear markets discount a 10-20% earnings decline, and most recover within a few years. That doesn’t mean this time has to follow the script – but to bet on the exception – can be costly on the gains you might miss out on.
This information is provided for educational purposes only and is not a recommendation or an offer or solicitation to buy or sell any security or for any investment advisory service. The views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Opinions discussed are those of the individual contributor, are subject to change, and do not necessarily represent the views of Fidelity. Fidelity does not assume any duty to update any of the information.
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