Test Your Smarts on…Stock-Market Cycles – Wall Street Journal

When the bear market arrives, does a recession always follow? See Question No. 7.


John W. Tomac for The Wall Street Journal

It has been a while since the last U.S. recession and a bear market in stocks, so investors can be forgiven for forgetting what tough times look like.

High time for a refresher.

Stock-market volatility is back with a vengeance, credit costs are rising steadily, and the prospects of a trade war are casting a shadow on economic forecasts. For years, economists talked about the “missing pieces” in the economic recovery—accelerating job growth, inflation and higher wages. Well, the global economic recovery has now ticked all the boxes, and the new parlor game on Wall Street is predicting the top of the bull market and the peak of the economic cycle.

For those with vague memories of the last economic downturn, here is a quiz on some of the terms and concepts that could soon be on investors’ minds:

1. When does a bull market officially become a bear market?

A. When a broad U.S. stock market index, usually the S&P 500, drops 20% from a closing peak.

B. When a broad U.S. stock market index falls 20% in a single day.

C. When the chairman of the Federal Reserve declares it officially.

D. When a groundhog named Charles Dow emerges from its hole in Punxsutawney, Pa., and claws downward instead of upward.

ANSWER: A. The S&P 500 is currently about 7% below its record close of 2872.87 on Jan. 26. Should it close below 2298, the broad index would be 20% below the record, resulting in the first U.S. bear market in almost a decade.

The bull and bear imagery derives from an old idea about investment styles. Bulls crouch down low to pick things up and toss them at a height. Bears swipe downward from a height and toss their acquisitions behind them on the following upswing.

2. What’s the difference between a bear market and a correction?

A. Nothing. They are different terms for the same phenomenon.

B. Trick question. There’s no agreed definition for a stock-market correction.

C. A bear market is a decline of 20% in the S&P 500 from a recent peak; a correction is a decline of 10% in the S&P 500 from a recent peak.

D. A correction means a bear market has extended it losses an additional 20%.

ANSWER: C. On Feb. 8, the S&P 500 closed at 2581.00, more than 10% below its Jan. 26 high. That was the fourth time during the current bull market that the index had been in official correction territory. The most severe correction—considered by some to be a bear market—was a 19.9% retreat in April 2011 as fears about Greece and the eurozone reached fever pitch.

3. When did the current bull market begin, and why is it dated back to that moment?

A. Oct. 20, 1987. Bull markets start the day after a stock crash.

B. March 9, 2009. That’s the day the Federal Reserve cut rates to zero.

C. Dec. 15, 1989. Coincidentally, when the “Charging Bull” bronze statue was installed on Wall Street.

D. March 9, 2009. That’s when the S&P 500 reached the low point of the last bear market, closing at 676.53.

ANSWER: D. A bull market happens when a major index sustains a 20% advance from a bear-market low. On March 9, 2009, the stock market didn’t feel very bullish. The despair was almost as palpable as it was on the day that Lehman Brothers failed. The Atlantic’s website ran an item on March 8 titled: “Ask the editors: What Happens if Citigroup Fails.” It’s this kind of “capitulation”—unfettered anguish throughout the stock market—that often turns out to be the painful birth of a new bull market. Nobody knows at the time whether the bounce will grow into something more lasting. Only in hindsight can chartists date the bull market back to the low point of the bear market. By August 2009, the S&P 500 had risen by roughly 50%, and strategists from

Goldman Sachs Group

and elsewhere were hanging garlands on the new bull.

4. Where does the current bull market rank in terms of longevity among the longest bull markets?

A. It’s the shortest bull market since 1937.

B. It’s the longest bull market in history.

C. It’s the second-longest, trailing only the bull market of 1987 to 2000.

D. It’s the third-longest, trailing the bull market of 1987 to 2000 and the “What Great Depression?” bull market that ran from 1929 to 1945.

ANSWER: C. The bull market turned 9 in March. At its most recent peak, in January, the S&P 500 had more than quadrupled from its low. Stock bulls claim there is a “new bull market” because the economic and financial policies of the current administration are so different from those of the last administration. The bears like to remind investors that “new paradigm” is a dangerous phrase that was popular before crashes in 2000 and again in 2009. One market saw says that bull markets “do not die of old age.” Medical science suggests the same may be true of humans. However, it’s also true that the older you get, the more likely you are to die.

If you look outside the stock market, however, this bull market may not seem that superannuated. By some measures, the bull market in Treasury bonds has lasted for more than 30 years.

5. What’s the difference between a cyclical bull market and a secular bull market?

A. Cyclical bull markets end as soon as a bear-market decline (a 20% decline from a closing peak) occurs. A secular bull market, on the other hand, continues as long as stocks reach “higher highs” in the aftermath of a bear market where stocks didn’t breach the previous bear market’s lows.

B. A cyclical bull market happens every four years.

C. A secular bull market doesn’t include stocks associated with religious matters, while a cyclical bull market consists only of economically cyclical stocks.

D. A cyclical bull market refers to a pattern on stock charts that looks like a bicycle.

ANSWER: A. On March 9, 2009, the S&P 500 closed at 676.53, far below the trough of 776 during the prior bear market in 2002. As a result, the charts showed that the secular bull market that began in 1982 had officially ended in 2007, the pre-financial-crisis peak. During those 25 years, there had been several corrections, a couple of bear markets and even a couple of crashes by some definitions (the most common of which is a 20% drop in a short period). Some portion of the gains amassed during each cyclical bull market had always been retained during those selloffs, however. In the brutal 2007-09 bear market, the work of not one but two cyclical bull markets was undone.

6. What is a recession?

A. A recession is loosely defined as two consecutive quarters of negative economic growth. In the U.S., this indicator is confirmed by a finding from the National Bureau of Economic Research.

B. A recession is defined as four consecutive quarters of negative economic growth.

C. A recession is when the stock market falls 20% from a recent peak at the same time that the unemployment rate rises above 5%.

D. A recession is when the unemployment rate rises above 5%.

ANSWER: A. As a rule of thumb, a recession is happening in the U.S. when the Commerce Department’s gross-domestic-product report shows that the economy has contracted for two quarters in a row. There are occasions, however, when nations register slowdowns (or big gains) for technical rather than fundamental reasons. To avoid misleading reads of raw economic data, a committee convened by economists’ nonprofit guild, the National Bureau of Economic Research, confirms the statistics by publishing a declaration that the U.S. is in recession.

7. Does a bear market mean that a recession is on its way?

A. In theory, no. But in practice, almost always yes.

B. No. The stock market has no link to the real economy.

C. Yes, the Federal Reserve will officially declare a recession when a bear market occurs.

D. Yes. An increase in the bear population, particularly grizzlies, is bad for the economy.

ANSWER: A. While there is no direct connection between the price of individual securities and the rate of GDP growth, there are plenty of indirect connections. Over time, the pace of earnings growth—a key component of pricing stocks—has a loose correlation with the pace of economic growth. Changes in Federal Reserve policy, which has a direct effect on the economy, also can cause drastic reactions in the stock market. Whatever dynamics are at work, there is a very strong correlation between bear markets and recessions. “Since 1929 there have been 16 bear markets that in all but one period coincided with a recession,” say analysts at brokerage Janney Montgomery Scott in a research note.

8. What are the odds of a recession in the next 12 months?

A. 1 in 2.

B. 1 in 5.

C. Impossible to gauge.

D. Low, but rising.

ANSWER: D. If the current stock-market correction (a correction is in force until the previous peak is surpassed or a 20% drop occurs) turns out to be a bear market, the odds would certainly rise. Right now, there is no sign of a recession in economic data. The new Federal Reserve chairman,

Jerome Powell,

said the central bank’s impression is that economic growth is strengthening. At the same time, Mr. Powell conceded that the Fed’s rate-setting committee is watching the impact of trade disputes on the economic outlook. And Mr. Powell was speaking before President Donald Trump threatened to impose tariffs on up to $150 billion of Chinese imports, and before China fired back.

One strategist said the Trump administration’s decision to cut taxes and regulations at a time when the economy was already booming could, counterintuitively, heighten recession odds.

“It’s like throwing gasoline on an already roaring fire,” said

Michael Arone,

chief investment strategist at the U.S. SPDR unit of State Street Global Advisors. “This approach may result in insufficient resources when the inevitable economic rough patch occurs. What’s more, this poorly timed fiscal policy may temporarily and artificially boost economic growth which is likely to increase inflation.”

Mr. Curran, a writer in Denton, Texas, is a regular contributor to Dow Jones Newswires and The Wall Street Journal. Email him at rob.curran@dowjones.com.

Appeared in the May 7, 2018, print edition.