US stocks have been slammed over the past month, but history says that might actually be a good thing for bullish investors

Raymond Boyd/Getty ImagesPlace your bets.
  • The US S&P 500 Index has been slammed since the start of October, losing as much as 7.8% before recovering in recent days.
  • According to historical analysis from Morgan Stanley, the more abrupt the initial selloff in the index, the more likely it is to be a correction rather than the start of a bear market.
  • Outside of historic relationships, it says movements in other asset classes make it hard to determine if this correction is the start of a bear market.

US stocks have been slammed since the start of October, including the S&P 500 Index.

From the high of 2,940.91 points hit on October 3, the index subsequently plunged 7.8% over the next six trading sessions before bouncing in recent days.

Many are now pondering if the correction is the start of something more sinister, potentially marking the end of the bull markets that’s propelled stocks to stratospheric levels since the dark days of the GFC.

While no one knows the answer, if history is a guide, the harder the initial fall, the less likely it is to be the start of a bear market.

The chart below from Morgan Stanley provides some food for thought.

It shows the relationship to the size of an initial fall in the S&P from record highs to the percentage change 12 months from the initial fall.

Morgan Stanley

More often than not, when the initial drop exceeds 6% in the first month, rather than marking the start of a bear market, it usually means the index will finish higher in 12 months time, at least according to data dating back to 1950.

In contrast, initial declines of less than 6% in the first month, especially when between 3% to 6%, often act as a lead indicator for further declines ahead.

“When S&P sells off by 6% or more over one month, more than 80% of the time the index recovers within the next 12 months,” Morgan Stanley says.

“It’s less clear to us this time round whether it’s a bull correction or the start of a bear market, but the severity of the latest sell-off leans towards the former.”

Obviously, past performance is not indicative of future returns, but for those who are interested, the decline from peak struck on September 21 to the close on Monday was 6.29%.

Pushing history to one side, Morgan Stanley says there were contrasting factors in the latest selloff that make it hard to determine if this is “the one”.

“The large rise in US real and nominal yields in the run-up to the latest selloff is very typical of a bear market experience, where tighter financial conditions tip equities over. Similarly, the rally in crude and credit spread widening, excluding high yield US debt, over the last 12 months is also reminiscent of prior bear market episodes,” it says.

However, conflicting with those prior signs of a looming bear market, it notes: “the sideways/tighter path of US high yield credit over the past year also resembles a typical bull correction episode rather than a bear market”.

“Credit in general has held in OK during the latest sell-off, close to what’s generally observed in bull corrections,” it says.

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