- The S&P 500 briefly entered a bear market on Monday, dropping 21% from its February peak.
- The market plunge was driven by Trump’s widening of the trade war last week.
- Event-driven bear markets can quickly shift to cyclical bear markets if the economy slows.
The S&P 500 briefly entered a bear market on Monday, falling 21% from its mid-February peak.
The uncertainty of President Trump’s tariffs, which Wall Street views as much higher than initially thought, plunged the market into chaos over the past week.
An increase in market volatility has strategists at Goldman Sachs dusting off their bear market playbook and examining the various paths stocks can take based on historical trends.
Here’s what to expect if the stock market decisively enters bear market territory.
There are 3 types of bear markets
Structural, cyclical, and event-driven are the three types of bear markets that stocks could fall into.
Goldman argues that the market is currently flirting with an event-driven bear market, given that tariffs were the key catalyst to spark the recent plunge, with the S&P 500 immediately declining 10% after Trump announced his tariff list.
"This could be seen as self-inflicted, given the strong prospects for global economic activity at the start of the year, particularly in the US, where our economists put the probability of recession at just 15%," Goldman Sachs said.
The odds of a recession striking the US economy this year have since risen past 50%, according to betting markets and various economists.
Furthermore, Goldman said that an event-driven bear market could easily turn into a cyclical bear market if the economy materially slows down.
How deep could the sell-off go?
If the S&P 500 closes down 20% from its peak and officially triggers a bear market, there could be more pain ahead.
According to the bank, the average event-driven and cyclical bear market experiences a decline of about 30%.
"On that basis, we would expect further downside," Goldman Sachs said. "Very low unemployment (which is likely to rise) and elevated valuation suggests that markets are still vulnerable to the downside."
A peak-to-trough decline of 30% would send the S&P 500 to about 4,300, or about 18% lower from current levels.
How long could a bear market last?
If an event-driven bear market strikes, the decline and eventual rebound could be quick.
Goldman highlighted that this type of stock market decline tends to last about eight months, with a full recovery seen in about a year.
But if this event-driven shock to the stock market transforms into a cyclical bear market, it could last a lot longer; the decline would last about two years, and it would take five years to fully rebound.
Don't be fooled by bear market rallies
Some of the strongest rallies in the stock market have historically occurred during bear market sell-offs.
That's potentially what's on display on Tuesday, with the S&P 500 surging 4% after its brutal three-day sell-off.
"Given the very sharp falls in investor sentiment over the past few days, it would be typical for there to be a bounce in equity prices," Goldman Sachs said.
Strong bear market rallies are driven by light investor positioning, meaning it only takes a little bit of buying, combined with little selling, to drive markets a lot higher on a given day.
Ultimately, bear market rallies could last weeks before continuing their downtrend to new lows, with the average bear market rally lasting 44 days and returning 13%.
The 4 ingredients for a recovery
For a bear market in stocks to fully recover and transition into a bull market, four conditions need to materialize.
- Valuations need to be attractive
- Bearish positioning among investors needs to hit extremes
- Policy support from the Fed or the government
- A positive outlook for economic growth
According to Goldman, those conditions have not yet been met , with valuations remaining expensive, no indication of support from the Fed or Congress, investor positioning still not at extremes, and growth expectations not improving.
"It remains premature to expect growth momentum to bottom. Equity markets are particularly sensitive to the higher-frequency survey data, which remain very weak. The near-term earnings season is also likely to be weak," Goldman said.