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Research & Insights

The Archetypical Equity Cycle and the Anatomy of a Bear Market

As the Fed transitions toward tightening, it will be increasingly important for investors to understand the drivers of a bear market in equities and the approaches to managing through it.

While the most all-encompassing perspective of an equity market is from the bottom up, i.e., an aggregation of companies, the top-down influence accounts for a substantial portion of what drives equity markets, and, according to our measures, the top-down forces have been fading and are in the process of rolling over. Given this leveling off and the approaching transitions in monetary policies, this is a good time to review the equity cycle, the anatomy of a bear market, and approaches to managing through it.

Viewing the Equity Cycle Through an All Weather Lens

We make the above observation based on a view of markets that we refer to as an All Weather Lens. This perspective views the pricing of assets as discounting future economic conditions and the returns of assets as driven by how conditions transpire in relation to what is discounted. Viewed through this lens, four major forces account for a substantial portion of what drives equity returns: changes in discounted growth, discounted inflation, discount rates, and risk premiums. Monetary policy and liquidity conditions are an important influence on these conditions.

The equity market and nearly all markets have relatively stable betas to these four forces and their returns reasonably track the beta-weighted sum of these forces. For example, below we show the return of world equities (blue) compared to what you would expect based on the beta-weighted sum of what has been going on with these four forces since early 2020 (red). Up until recently, prices tracked macro conditions closely. In recent months, the fundamental macro pressures have leveled off while equity prices have continued to gradually rise.

Archetypical Equity Cycle Anatomy of Bear Market_01.png
The analysis in the above chart is based on the All Weather Lens, which is an analytical approach to assess the behavior of the major drivers of asset performance and their impact on markets during any given period, based on Bridgewater’s understanding of global financial markets. Information shown is the result of analyses of actual and simulated market data. Please review the “Important Disclosures and Other Information” located at the end of this research paper.

The Influence of the Liquidity Cycle

A key driving force of these conditions is the liquidity cycle, and in particular whether money is moving from cash to assets, in which case it’s also moving from cash to spending, or from assets to cash, in which case spending falls. This is primarily under the control of the central bank, though the financial system also plays a role. As illustrated below, in the current cycle, we’ve transitioned from the stage where massive stimulation pushes risk premiums down and assets and growth up to the stage where growth is now pushing inflation higher. When central banks determine that inflation is a problem, you get a tightening, which reverses the flow of money from assets to cash, pushing risk premiums up and assets down, ultimately slowing growth until inflation is no longer a problem.

Archetypical Equity Cycle Anatomy of Bear Market_02.png

The Anatomy of a Bear Market

The equity market has a relatively stable beta to each of the four key macro conditions across all stages of the cycle. Starting from roughly where we are now, a rise in inflation is a moderate drag. What typically follows is a rise in discount rates from the tightening, which is an additional drag. When the tightening is aggressive enough, you get the rise in risk premiums, which is another incremental drag. And when that causes a credit contraction and downturn in growth, further downward pressure is added. The sum of the forces roughly equates to the size and direction of the equity move. Furthermore, each of these conditions is an influence on the next, such that they tend to unfold in roughly that order. We illustrate the archetypical bear market below. The tipping point will be around the time that the weight of the forces rolls over, though sentiment and flows obviously play a role regarding timing.

Archetypical Equity Cycle Anatomy of Bear Market_03.png

This sequence of events means that hedging a bear market or profiting from it is best achieved across the full cycle, from the rise in inflation (breakeven inflation, commodities) and interest rates (short rates, yield curve, long rates) leading into the peak, to the spike in risk premiums (credit spreads, implied volatility), to the decline in discounted growth (stocks versus bonds, cyclicals versus stables, strong versus weak balance sheets), to the eventual decline in inflation (breakeven inflation, commodities) and monetary easing (short rates, yield curve, long rates). In other words, by positioning for each of the forces that cause a bear market, there is a series of opportunities across a diversified set of positions prior to, during, and after the price decline. In fact, because an equity market is a singular package of forces, there is more opportunity for positioning in the pieces than in the package.

The depth of a price decline will depend on the degree of the beta-weighted sum of these forces. But by and large, the difference between a correction (e.g., 10-20% decline) and a bear market (e.g., a greater than 20% decline) is the extent to which the contraction in liquidity and rise in risk premiums passes through to an economic contraction and a collapse in earnings.

Archetypical Equity Cycle Anatomy of Bear Market_04.png

You see this in the data shown below, covering 41 bear markets and 30 corrections over the past 100 years in the four largest developed world markets. In corrections of 10-20%, the price decline is mainly comprised of a rise in risk premiums and fall in P/Es, and the change in earnings and economic growth is not much. In bear market declines of 20% or more, the price impact of the earnings decline is much bigger than the impact of risk premiums due to a deeper contraction in the economy.

Archetypical Equity Cycle Anatomy of Bear Market_06.png

Going to the individual cases, the following table shows the beta-weighted influence of inflation, discount rates, risk premiums, and discounted growth in the year leading up to the top, the move from the peak to the bottom, and the year after the bottom for all of the equity bear markets (defined as a decline of more than 20%) across five major economies since 1900. What you see is that in the year leading into the peak, discount rates are generally a negative influence as monetary policy is beginning to tighten, typically due to rising inflation, which is also a drag, but risk premiums and growth are still a favorable influence as the tightening has not yet begun to bite. From peak to trough, you see that rising risk premiums and falling growth are almost always big negative influences, discount rates have become a positive as central banks ease, and typically inflation remains a drag but with variations depending on the nature of the inflation cycle. In the year following the trough, discount rates remain a positive influence, with that easing passing through to a decline in risk premiums and eventually to a pickup in discounted growth.

Archetypical Equity Cycle Anatomy of Bear Market_07.png
The analysis in the above chart is based on the All Weather Lens, which is an analytical approach to assess the behavior of the major drivers of asset performance and their impact on markets during any given period, based on Bridgewater’s understanding of global financial markets. Information shown is the result of analyses of actual and simulated market data. Please review the “Important Disclosures and Other Information” located at the end of this research paper.

On a Forward-Looking Basis, Macro Influences Are Continuing to Roll Over

The following chart shows our forward-looking estimates of these macro conditions and their estimated beta-weighted impact on global equities. As shown, during the early phase of the liftoff, forward-looking pressures were positive from all four influences. Over time, leading indicators of these macro influences have gradually waned and are now on balance moderately negative globally. Of course, flows, sentiment, and the circumstances of companies are required for a holistic view of equity markets and are not reflected in this chart. And there are differences across countries. But what it does convey is that the macro environment that we are headed into is far less supportive than what has existed over the past couple of years.

Archetypical Equity Cycle Anatomy of Bear Market_05.png
The analysis in the above chart is based on the All Weather Lens, which is an analytical approach to assess the behavior of the major drivers of asset performance and their impact on markets during any given period, based on Bridgewater’s understanding of global financial markets. Information shown is the result of analyses of actual and simulated market data. Please review the “Important Disclosures and Other Information” located at the end of this research paper.


This research paper is prepared by and is the property of Bridgewater Associates, LP and is circulated for informational and educational purposes only. There is no consideration given to the specific investment needs, objectives or tolerances of any of the recipients. Additionally, Bridgewater's actual investment positions may, and often will, vary from its conclusions discussed herein based on any number of factors, such as client investment restrictions, portfolio rebalancing and transactions costs, among others. Recipients should consult their own advisors, including tax advisors, before making any investment decision. This material is for informational and educational purposes only and is not an offer to sell or the solicitation of an offer to buy the securities or other instruments mentioned. Any such offering will be made pursuant to a definitive offering memorandum. This material does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors which are necessary considerations before making any investment decision. Investors should consider whether any advice or recommendation in this research is suitable for their particular circumstances and, where appropriate, seek professional advice, including legal, tax, accounting, investment or other advice.

The information provided herein is not intended to provide a sufficient basis on which to make an investment decision and investment decisions should not be based on simulated, hypothetical or illustrative information that have inherent limitations. Unlike an actual performance record simulated or hypothetical results do not represent actual trading or the actual costs of management and may have under or over compensated for the impact of certain market risk factors. Bridgewater makes no representation that any account will or is likely to achieve returns similar to those shown. The price and value of the investments referred to in this research and the income therefrom may fluctuate. Every investment involves risk and in volatile or uncertain market conditions, significant variations in the value or return on that investment may occur. Investments in hedge funds are complex, speculative and carry a high degree of risk, including the risk of a complete loss of an investor’s entire investment. Past performance is not a guide to future performance, future returns are not guaranteed, and a complete loss of original capital may occur. Certain transactions, including those involving leverage, futures, options, and other derivatives, give rise to substantial risk and are not suitable for all investors. Fluctuations in exchange rates could have material adverse effects on the value or price of, or income derived from, certain investments.

Where shown, the All Weather Lens is an analytical approach to assess the behavior of the major drivers of asset performance and their impact on markets during any given period, based on Bridgewater’s understanding of global financial markets. Information shown is the result of analyses of actual and simulated market data.

Bridgewater research utilizes data and information from public, private and internal sources, including data from actual Bridgewater trades. Sources include, 4Cast Inc., the Australian Bureau of Statistics, Asset International, Inc., Barclays Capital Inc., Bloomberg Finance L.P., CBRE, Inc., CEIC Data Company Ltd., Consensus Economics Inc., Corelogic, Inc., CoStar Realty Information, Inc., CreditSights, Inc., Credit Market Analysis Ltd., Dealogic LLC, DTCC Data Repository (U.S.), LLC, Ecoanalitica, EPFR Global, Eurasia Group Ltd., European Money Markets Institute – EMMI, Factset Research Systems, Inc., The Financial Times Limited, GaveKal Research Ltd., Global Financial Data, Inc., Harvard Business Review, Haver Analytics, Inc., The Investment Funds Institute of Canada, Intercontinental Exchange (ICE), Investment Company Institute, International Energy Agency, Investment Management Association, Lombard Street Research, Markit Economics Limited, Mergent, Inc., Metals Focus Ltd, Moody’s Analytics, Inc., MSCI, Inc., National Bureau of Economic Research, North Square Blue Oak, Ltd , Organisation for Economic Cooperation and Development, Pensions & Investments Research Center, RealtyTrac, Inc., RP Data Ltd, Rystad Energy, Inc., S&P Global Market Intelligence Inc., Sentix Gmbh, Shanghai Wind Information Co., Ltd., Spears & Associates, Inc., State Street Bank and Trust Company, Thomson Reuters, Tokyo Stock Exchange, TrimTabs Investment Research, Inc., United Nations, US Department of Commerce, Wood Mackenzie Limited World Bureau of Metal Statistics, and World Economic Forum. While we consider information from external sources to be reliable, we do not assume responsibility for its accuracy.

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