Predictors of Bear Markets

Updated: November 15, 2019

One of the biggest dangers for soon to be retirees and recently retired folks are bear markets. We saw this in the first 2000 decade when stock returns were negative for the 10 year period, something no one had planned for in retirement.  

Yet we know stock markets build wealth over time and that bear markets are a fact of life for stock market investors. 

But if we take it a step further and consider the predictors of bear markets in our wealth planning, we can lower risk while also having funds to invest after bear markets.  

If you’re a regular reader here at Retire Certain, you know I love using historical data to make investment decisions. This saves us from making emotional decisions.  

This leads me to share a revealing Bear Market Checklist I discovered that has 18 predictors of bear markets. While over exuberance, political turmoil and the market being led by only a few stocks are good signs for a bear market, these 18 predictors of bear markets are pure data based and thus, easier to measure.  

Call me a nerd, but I was excited to share this with you. I tend to be cautious of stock market risk at my age.

Read my related post How to Manage Risk in the Stock Market.


The most recent data as of this writing, however, shows almost all the bear market predictors indicate the bear is not close. 
 

This may have changed by the time you read this, but you can always refer to the Citibank Bear Market Checklist now that you know about it. Citibank updates the checklist, so at any time, you can google search for it with updates. (I couldn’t find a link to it at Citi.) 

The chart below is from a July 2019 post on CNBC.com. Since this data is not changing daily or even weekly, I consider it very relevant.  

There is a lot of great data here about various bear market predictors but here are a few of my favorites.  

Before you even get started, you can see how a bear market will affect you in my post if you’re not sure or Are Stocks Safe for Retirement?

Invested Yield Curve 

In the checklist, an invested yield curve is indicated by a 2 Year Treasury note yielding more than a 10 Year Treasury bond. Normally, a longer term investment has a higher yield than a shorter term investment.  

An inverted yield curve is a reliable predictor of a recession. As you have read here, bear markets happen when (usually after) the economy slows since company earnings slow. In case you missed it, catch up by reading “How to Prepare for Bear Markets.” 

Note that whether or not the yield curve is inverted can change whenever the Fed changes interest rates.  

(See what Ray Dalio, Warren Buffett and major investing experts are doing in my post What Will Stocks Do over the Next 10 Years?)

Trailing PE Ratio 

PE stands for price earnings ratio. This relates to stock market valuations, another popular topic here at Retire Certain.  

You get the PE ratio by dividing the price of a stock by the earnings of a stock, but a single stock’s PE ratio won’t tell us much about the stock market as a whole.  

So, we use the PE ratio for a stock index instead since an index represents a market vs a single stock.  

And the Trailing refers to the past 12 months earnings.  

This is as opposed to future earnings, which really can only be estimated. The chart calls this “Fwd PE, which stands for Forward PE ratio.  

Here’s the logic behind the PE ratio and using it as a predictor of bear markets: Investors are willing to pay up to a certain amount for earnings before they decide they are paying too much.  

And once investors decide they need to pay too much for stocks, they stop buying them. They may even decide to start selling stocks because valuations have gotten so high.  

You can see the simple logic here. Again, when we invest with logic, historical data and math we are less likely to invest with emotions. (Been there and done that.) 

Read my post with related information: Best Assets to Build Wealth.

CAPE   

The CAPE is a new and improved PE ratio. It stands for Cyclically Adjusted Price to Earnings ratio.  

The CAPE is obtained by dividing the average earnings in the prior 10 years adjusted for inflation.   

This tells us how much of a company’s (or the stock market’s) earnings were from inflation vs true earnings.  

To put this in perspective, the CAPE has had record high levels only 3 times in the past: 

  1. In 1929 
  2. In late 1990’s before the Dotcom bear market
  3. In 2007  before the bear market of 2007-2009

Although there are critics of this ratio, the facts above make the CAPE ratio a reliable bear market predictor in my humble opinion.  

Balance Sheets and Credit Markets 

Net Debt/EBITDA is another red warning on this chart. There are also 2 gold warnings under this category.  

EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization.  

So, by dividing the Debt by EBITDA, you can get a leverage measurement.  

High leverage is risky.  

My post Reducing Risk in Stocks has more about stock market risk.

Reliability of Bear Market Predictors 

While it’s comforting to see that only three of the bear market predictors are red, there are several things worth mentioning.  

History from More Bear Markets 

I notice that the data is only shown for the bear markets that began in 2000 and 2007. What would this data reveal if other bear markets were considered? 

My post Stocks That Went Up in 2008 has information about stocks, gold and ETF’s that went up in the 2008 bear market.

Conflicting Data 

At any given time, we can find data to support continuing bull markets as well as looming bear markets. Data can be presented in different ways to reflect the intended and desired message of the company that produces it 

While this data is clearly solid, we could find conflicting data if we tried.  

Stock Market Risk 

You may not want to concern yourself with predicting bear markets, especially if any of the following apply: 

  1. You have plenty of wealth to sustain your standard of living for life.
  2. You have several income streams that will pay your bills without having to sell stocks during bear markets. 
  3. You are a young investor who has chosen a diversified, long term buy and hold investing strategy.   

If the above don’t apply, or if you want to invest more proactively so you can build wealth off the bottom of the next bear market, you may want to read my post on how much cash to have in your portfolio.  

Summary for Predictors of Bear Markets 

No one can ever guess the exact time the next bear market will raise its gnarly head and roar. But by being aware of the predictors of bear markets, you can invest accordingly.   

 

Wealth Building Strategies eBookIf you’re interested, get my newsletter and grab my free eBook on wealth building strategies that generate income streams in retirement, too.  

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Disclaimer: Nothing in this post is meant to be taken as personal financial advice. Only you are responsible for your own money.

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