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FA Center: How bad will the next bear market be?

Especially long bull markets aren’t always followed by especially long or severe bear markets. In fact, more often than not, they’re followed by shorter-than-average declines.

That’s important information because many are worried about the bear market that eventually will follow the current U.S. bull market, supposedly the longest in U.S. history. Just this week, one of the investment newsletters I monitor noted that “long duration bull markets always create excesses.”

If “the higher they go, the harder they fall” were true, then an exceptionally severe bear market is indeed in our future. But history doesn’t support that argument: There is no correlation between a bull market’s duration and the length and the severity of the subsequent bear market.

Stock investors can relax for another reason as well. Notwithstanding the current narrative that the bull market is 11 years old, it actually is much younger: less than four years old, in fact. There have been two bear markets since 2009, according to the bull-bear calendar maintained by Ned Davis Research. That means that, even if longer bull markets were reliably followed by longer bear markets, there would be no particular reason to worry now.

To measure the correlation between bull- and bear-market length, I relied on that Ned Davis calendar, according to which there have been 36 bear markets since 1900 and 37 bull markets.

Upon feeding those dates into my PC’s statistical software, I discovered that in fact there is an inverse correlation between a bull market’s length and the duration of the subsequent bear market. This correlation was significant at the 95% confidence level that statisticians often use when determining if a pattern is genuine. Which means that, to the extent the future is like the past, you’d expect that longer bull markets are more likely to be followed by shorter-than-average bear markets— and vice versa.

I next measured the correlation between a bull market’s length and the magnitude of loss in the subsequent bear market. This time there was no correlation one way or the other. While that means you can’t conclude that long bull markets are usually followed by below-average bear market losses, there still is no reason to worry that those losses will be greater than average.

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To be sure, none of these results provide any guarantee that the next bear market won’t be a terrible one. Instead, the lesson of the historical record is that, if you want to argue that the upcoming bear market will be a bad one, you will have to base your argument on factors other than the alleged length of the current bull market.

There are plenty of those other factors on which to focus, should you choose. This market currently is extremely overvalued according to a number of valuation indicators, for example. One such indicator — the Cyclically Adjusted P/E ratio, or CAPE — is currently higher than 96% of monthly readings since 1871. According to a simple econometric model that uses historical data for the CAPE and the S&P 500 SPX, +0.63% to predict bear market severity, the next bear market will produce a 35% loss in the Dow Jones Industrial Average DJIA, +0.53% . While that is larger than the 31.1% average loss of all bear markets since 1900, it is a lot less than the more than 50% loss incurred during the 2008-09 financial crisis.

The bottom line? While there undoubtedly are many things you can worry about the current bull market, its remarkable longevity is not one of them.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected]

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