What causes a bear market? How does it get started, and how does it end? What happens to stock fundamentals during these bearish times? There are no ironclad rules that can teach you to identify the beginning and end of bear markets to come, but there are some similarities that all bear markets share. Understanding the way bear markets work can help you become a better and more informed investor -- and if you're the inquisitive sort, you're also bound to find some interesting parallels between otherwise unrelated market cycles. History may not repeat, but it often rhymes.
Here, in the second part of a three-part series, you'll find an overview of notable bear markets, from the middle of the Great Depression to the height of the Cold War, in the history of the Dow Jones Industrial Average. Each bear market overview includes some basic background data, some of the market's major fundamental changes during those periods, and a brief description of the economic, social, technological, financial, and political forces at work. When you've finished reading, don't forget to check out the other parts of this series, as well as the companion series to this one that highlights the Dow's many bull markets. You can find the links below.
1937-1938: Echo recession
Began (starting price): March 10, 1937 (194.4)
Ended (final price): March 31, 1938 (98.95)
Number of trading days: 268
Total percentage loss and average loss per trading day: 49%, 0.18% per day
Volatility (i.e., average daily price change): 1.32%
CAPE, initial and final: 22 to 11.8 (47% decline)
The Japanese invasion of China, combined with rising belligerence in Europe and a change in U.S. economic policy, sent the Dow into tailspin. Industrial production fell harder than it had in 1930, and steelmakers saw their output capacity plummet to just 20%. The domestic causes have been debated -- Keynesians argue that austerity measures were to blame, while monetarists and Austrians point to money-supply problems as the root issue.
1938-1939: Prewar jitters (part two)
Began (starting price): Nov. 9, 1938 (158.08)
Ended (final price): April 11, 1939 (123.75)
Number of trading days: 103
Total percentage loss and average loss per trading day: 24%, 0.03% per day
CAPE, initial and final: 16.1 to 13.9 (14% decline)
A short, relatively shallow bear market began after the Munich Agreement, which ceded the Sudetenland to Germany and resulted in the infamous "peace for our time" speech. Investors feared the onset of war, and they would soon be proven correct.
1939-1942: World War II gloom
Began (starting price): Sept. 12, 1939 (155.92)
Ended (final price): April 28, 1942 (92.92)
Number of trading days: 656
Total percentage loss and average loss per trading day: 40%, 0.06% per day
CAPE, initial and final: 16.5 to 8.5 (48% decline)
This bear market began soon after the German blitz of Poland and continued until America was earnestly engaged in the war following the attack on Pearl Harbor. An initial "war bride" buying frenzy collapsed within days of the blitz as it became more apparent that America's allies might be overrun. A rumor that the New York Stock Exchange might close only made the situation worse. The slide continued until after America's entry to war prompted the largest industrial surge in history.
1946-1949: Postwar hangover
Began (starting price): May 29, 1946 (212.5)
Ended (final price): June 13, 1949 (161.6)
Number of trading days: 762
Total percentage loss and average loss per trading day: 24%, 0.03% per day
CAPE, initial and final: 15.8 to 9.1 (43% decline)
The transition from wartime production to peacetime production was even more pronounced in 1946 than it was in 1919. More importantly for stocks, millions of workers in this economy became savers, rather than investors, as many still held bad memories of the speculation preceding the Great Depression. There were only 150 investment management companies operating at the end of 1949, managing only $2.7 billion in funds. Total daily volume at 1949's lowest point was only about $540,000 -- nearly 97% lower than it had been in 1929. However, this bear market was an outlier, as corporate earnings grew more than 200% in nominal terms and more than 120% when adjusted for inflation, a higher rate by far than experienced in any other bear market.
1956-1957: Red scare
Began (starting price): April 6, 1956 (521.05)
Ended (final price): Oct. 22, 1957 (419.79)
Number of trading days: 390
Total percentage loss and average loss per trading day: 19%, 0.05% per day
CAPE, initial and final: 19.4 to 13.7 (29% decline)
This shallow bear market is sometimes considered a mere correction. It occurred primarily in response to Communist-driven geopolitical events, particularly the launch of Sputnik and the Soviet invasion of Hungary. The Suez Canal crisis in mid-1956 also contributed to the decline.
1961-1962: Steel and tech crash
Began (starting price): Nov. 15, 1961 (734.34)
Ended (and final price): June 26, 1962 (535.76)
Number of trading days: 154
Total percentage loss and average loss per trading day: 27%, 0.18% per day
CAPE, initial and final: 21.9 to 17.1 (22% decline)
This bear market is sometimes associated with the Bay of Pigs and the Cuban Missile Crisis, but neither took place within this time frame. Rather, it was President John F. Kennedy's battle with U.S. Steel over its price hikes that precipitated a crash, as investors feared an antibusiness sentiment in the government. Many tech companies of the day, including IBM , were valued at unsustainably high levels. Before the crash, IBM had a P/E of 65, and other "Nifty 50" tech companies were similarly valued. However, this relatively mild bear market was only a speed bump on the road to more Nifty 50 gains.
1966: Credit crunch
Began (starting price): Feb. 9, 1966 (995.15)
Ended (final price): Oct. 7, 1966 (744.32)
Number of trading days: 168
Total percentage loss and average loss per trading day: 25%, 0.15% per day
CAPE, initial and final: 23.7 to 18.8 (21% decline)
This was the first bear market following the escalation of the Vietnam War, but investors were not yet preoccupied with it as they would be later in the decade. At the start of the year, CAPE ratios for the market were at their highest level since 1929, and the flow of investment money was drying up. Tight money led to fewer buyers, putting downward pressure on stocks despite a slowly expanding economy. A crisis of confidence hit Wall Street just as civil unrest began to simmer.
Putting it all together
Memories of the Great Crash of 1929 held much of the market's speculative tendencies in check during this period. As a result of reduced investor interest and greater investor caution -- particularly after the war -- many of the bear markets during this period were mild in terms of either total decline or their average daily declines. Politics had an especially outsize influence on the Dow during these years as a world war gave way to the Cold War and America always seemed on the brink of another great clash.
Want to learn more about market cycles? You can find the rest of the series here:
AUTHOR'S NOTE: the cyclically adjusted P/E you'll see referenced throughout is compiled by Yale economist Robert Shiller from a historical S&P 500 composite. The Dow is used in place of this composite because it offers precise daily closing dates and prices, rather than the monthly results used in Shiller's calculations. The difference between these two indexes from the Dow's creation in 1896, on an inflation-adjusted basis, is less than 3%.
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The article Recession, War, and Bear Markets originally appeared on Fool.com.
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