Today, despite being nearly a decade into the current expansion, the wounds of the Global Financial Crisis (GFC) still feel fresh. And while most macro signals continue to point to strong growth in the near future, recession-related anxiety has left many investors to wonder: when the next bear market comes, what will it look like? In fact, in our 4Q18 Guide to the Markets survey, an overwhelming 80% of financial professionals listed “worry over market correction / recession” as the most common question they are receiving from clients. 1
The GFC was the worst of the 12 post-Depression recessions. The subsequent capital market fallout was similarly extreme. But the GFC was fueled by a particularly lethal cocktail of excessive leverage, poor lending standards and inadequate risk controls, all of which came together in a disastrous fashion, leading to financial meltdown. Looking at today, the odds of another financial crisis seem slim: total private debt as a share of GDP, a proxy for leverage, is both sustainable and stable over the past five years; lending standards, particularly for mortgages, are tight; and post-crisis regulatory overhauls have improved bank capitalization dramatically. All of this suggests that the next recession should not look like the last one and, in fact, may be relatively mild.
The next bear market, too, could be relatively tame. The most recent bear market was triggered by a historically significant global economic downturn and banking crisis; before that came the bursting of the dot-com bubble, with peak valuations roughly 50% higher than the 25-year average. Today’s stock market looks less vulnerable, at least in comparison: current valuations are only modestly rich, and the next recession should be milder than the last.
Of course it is impossible to predict either recessions or bear markets with precession: any number of exogenous shocks may emerge, and perhaps unseen dangers lurk beneath the surface. As a result, investors should take care to position themselves appropriately, focusing on quality and adjusting risk exposure as necessary throughout the twilight years of this expansion.
The Global Financial Crisis was unusually bad
Length and severity of post-war recessions
1 A Survey was conducted with approved recipients of the 4Q18 Guide to the Markets release email, sent on October 2, 2018.
Source: BEA, NBER, J.P. Morgan Asset Management. Bubble size reflects the severity of the recession, which is calculated as the decline in real GDP from the peak quarter to the trough quarter, except in the case of the Great Depression, where it is calculated from the peak year (1929) to the trough year (1933) due to a lack of available quarterly data. Data are as of October 9, 2018.