WHEN A BEAR growls, it is natural to be frightened. Ditto in finance, where bear markets can mean rapid losses of wealth. The coronavirus pandemic led to the fastest equity bear market in history: the S&P 500 index, America’s main benchmark, took just 16 days in February to fall by 20%, the standard definition.
The bear also seems to have been an unusually short-lived member of its species. Although economic data have continued to deteriorate, share prices have staged a remarkable recovery. April was the S&P 500’s best month since January 1987. Having bottomed at 2,237 on March 23rd, it rallied by 27% by May 1st (see chart). Technically, that has put shares back into a bull market, even though they have yet to regain all their pre-pandemic losses.
One reason for this mismatch between the markets and the economy is that official attitudes to financial downturns have changed a lot since Andrew Mellon, America’s treasury secretary under President Herbert Hoover, argued after the crash of 1929 that downturns would “purge the rottenness out of the system”. Now central banks and governments respond vigorously to economic and financial trouble, and taxpayers may bear more of the burden of the crisis than investors. The swift partial recovery is just one way in which the bear market of 2020 has been an odd specimen.
The grizzly facts
It is far from clear how the term “bear market” originated. Daniel Defoe used the term “bearskin jobber” in the early 18th century. This may in turn be linked to a saying about how it was dangerous to sell a bearskin before catching the bear. Some speculators would agree to sell shares at the current price (but at a future date) even though they did not own them. To do this, they would borrow the shares, a practice known as “short-selling”, hoping to repay the loan with shares bought more cheaply. These bears thus wanted prices to fall. More optimistic investors became known as bulls. Some suggest this is because bulls strike up with their horns while bears swipe down with their paws.
The traditional template for a market cycle, outlined by Charles Kindleberger and Hyman Minsky, two economic historians, goes through five stages: displacement, boom, euphoria, crisis and revulsion. The “displacement” takes the form of some new, positive economic development—for example, a new technology, such as the internet—justifying greater prosperity.
Sure enough, a boom then occurs. Profits rise and investors steadily become more confident. Companies borrow to expand and investors take more speculative positions by, say, buying shares on margin (putting up only a small amount of the purchase price, with the rest to be paid later). In the boom’s early stages such strategies are highly profitable, and this encourages others to follow suit.
Enter euphoria. Property is often a particular focus of speculation: the peaks of bull markets are associated with the construction of skyscrapers. At the peak, people who do not normally speculate are drawn in: in the late 1990s, investors became “day traders” in technology stocks; in the early 2000s, more people became homeowners to profit from rising property prices. Because asset prices look high on conventional measures, optimists make up new ones to justify them (eg, price-per-click for internet companies). Sceptics are dismissed as dinosaurs who just “don’t get it”.
Eventually, the boom leads to inflation, as companies compete for scarce raw materials and workers. Central banks respond by pushing up interest rates. At first, this makes little difference. But eventually something happens to dent confidence. It can be hard to pinpoint what: it may simply be that a few investors decide to cash in and take their profits. But once prices stop rising, the machine starts going into reverse.
As asset prices fall, those who have bought on margin, or with borrowed money, are forced to sell. Banks become reluctant to lend. Nervous about the value of collateral, they ask some borrowers to repay. Novice buyers retreat from the market as the prospect of juicy gains becomes uncertain. So it is difficult for forced sellers to find new buyers. The fall accelerates.
Often a scandal is uncovered. Booms are an ideal opportunity for what J.K. Galbraith, a Canadian-American economist, called the “bezzle”: fraudulent schemes that allow insiders to bilk the public. Or the problem may simply be that executives at a company are revealed to have taken far more risks than was prudent. The Depression brought the collapse of the utilities empire built by Samuel Insull; another utility group, Enron, imploded during the bear market of 2000-02.