How to Spot an Impending Bear Market
Decoding Market Cycles with Peter Oppenheimer of Goldman Sachs
Introduction
If you listen to my podcast, and honestly you should, you will know that I am a keen student of financial history. I was joined in June by Peter Oppenheimer, chief global equity strategist and head of Macro Research at Goldman Sachs in Europe, to discuss his two excellent books. Amazingly, he has written these in his spare time, in spite of his hectic schedule as a Goldmans partner.
His first book, the Long Good Buy is sub-titled Analysing Cycles in Markets. His follow-up book Any Happy Returns, is sub-titled Structural Changes and Super Cycles in Markets and looks at longer term secular trends and looks to the future outlook for economies and markets. I thought the books were worth reprising for readers and I have outlined some of the main points of the books and of our discussion below. And of course, you should also really listen to the podcast and hear from the man himself.
The Four Phases of a Stockmarket Cycle
Peter has deftly categorised the stockmarket as having four phases in a typical cycle:
The Four Phases of the Equity Cycle
Source: Goldman Sachs Global Investment Research
In the Long Good Buy, Peter describes these phases as Despair, Hope, Growth and Optimism. The despair phase is normally characterised by recession and a steep fall in prices. The Hope phase tends to be quite short and in this phase, which tends to be quite strong, price is driven by valuation. The Growth phase is longer and companies see profits growth, but the recovery has already been anticipated in the Hope phase. And then comes increasing Optimism towards the end of the cycle - that can become exuberance and even develop into a bubble which will then dictate the extent of the fall when the market enters the next cycle.
Returns are quite different in these phases:
Returns in the 4 Phases
Source: Datastream, Haver Analytics, Goldman Sachs Global Investment Research
And so are the durations:
Bear Market Durations, Returns and Earnings
Market Concentration
The US has become a much bigger component of the global index and there is greater concentration at the stock level. It’s not just the Mag 7 in the US, one-third of the S&P500 capitalisation, the greatest concentration in 100 years; it’s similar in Europe – the GRANOLAs are one quarter of the European capitalisation. Peter doesn’t think this is irrational, rather it reflects fundamentals – the US corporate sector has outgrown the rest of the world and the tech sector, for example, has been extremely profitable. But although the concentration is not irrational, it creates a diversification risk for investors. This is not a new phenomenon, however, as you can see in the chart:
Market Concentration over Time
Source: Datastream, Goldman Sachs Global Investment Research
The railroads were dominant 150 years ago, the autos were dominant in the 1950s, the oil companies were dominant in the 1970s. And for a brief period before the financial crisis the banks were in the lead but Peter sees that as anomalous, a bubble.
Types of Bear Market
Most cycles end with bear markets but not all bears are equal. Cyclical bear markets are most common and are triggered by rising rates, and accompanied by falling profits. Historically, prices fall by around 30% on average. This takes 3-6 months. Event driven bear markets are triggered by an exogenous shock. They cause similar falls of 30% but they are sharp and short. Structural bear markets are rarer but are more severe – a fall of 60% can take 5-10 years to recover. They are usually preceded by bubbles, often with rising rates and accompanied by property crises where leverage magnifies the problems eg 1929, Japan in the 1980s and the GFC.
Spotting Bear Markets
Buying expensive markets generates low returns over a 10 year timeframe and that is the danger today. A period of rising unemployment after very low levels is also a potential signal of a bear market. The health of the private sector is also a trigger – if you have a lot of leverage and a rising rate cycle, then it can cause an unwinding of the leverage and forced asset sales and further problems. The quoted corporate sector today has been quite healthy and generally corporate sector and bank balance sheets have been more resilient to recent rate rises than they have been in the past.
The average bear market troughs around 9 months before a recovery in corporate earnings per share (S&P 500 actual earnings).
Bear Markets vs Corporate Earnings
Source: Goldman Sachs Global Investment Research
There is more debt in the private markets, and in the podcast, I suggested this is a concern. Peter thinks the data is harder in private markets and the history is much shorter and there is less regulation. He points out the weakness in the commercial real estate markets in the US but there haven’t been any real systemic effects and if interest rates come down quickly enough, then when refinancing is required, the cost of capital will be lower again. But he thinks we are not out of the woods yet and we should be attentive to private markets.
Fat and Flat Markets
In his second book, Peter explores longer term trends and highlights that the market can go through extended periods in a flat and often volatile range as shown in the chart.
Fat and Flat vs Bull Markets
Source: Goldman Sachs Global Investment Research
S&P Margins
In his book, Peter charts US Profit Share of GDP vs S&P Net Income Margin. This is similar to the NIPA vs S&P margin I use in my forensic accounting training and in both cases the S&P margins look high. Peter attributes this to lower tax rates benefiting international companies more and the S&P having a higher proportion of high margin tech. These definitely impact the results but I think a primary factor is S&P 500 companies boosting their margins through more aggressive accounting.
S&P500 vs NIPA Margins
Source: Wm Blair, 20/10/23
Peter reckons that buybacks have boosted eps particularly in the US and increasingly recently in Europe. He also thinks the compositional issue is important because the size of the high margin tech stocks has a disproportionate effect on the index’s margin. The secular rise in margins since the 1990s reflects multiple factors:
technology and innovation
the effect of increased world trade and globalisation
a trend to low tax rates
lower interest charges
In a period when there were ample supplies of commodities and labour pushing down input costs, the profit share of GDP rose. More recently, we are starting to see an inflection with labour costs going up, and there is evidence of corporate margins moderating.
Markets Outlook
That suggests slower markets for going forward – rates are unlikely to trend down and valuations are less likely to continue to rise. Profits growth is likely to be more differentiated across markets, sectors and companies. Nominal GDP growth will be moderate, with lower inflation. It will be positive but lower, with an ageing population, and returns across financial assets will likely be lower.
In the last decade, diversification in a multi-asset sense didn’t really benefit risk-adjusted returns. And within equities, all you wanted to own was US tech. Peter sees this as a product of abnormally low rates. Going forward, greater diversification will be beneficial, both across asset classes and across sectors within equities.
Correlations within markets has fallen and dispersion has increased which means the outlook for alpha generation has improved.
And there are two extremely important trends, AI and decarbonisation. AI requires massive amounts of power so we shall need a lot of physical infrastructure for this as well as for decarbonisation. These two trends will be quite transformational. AI can boost productivity and with decarbonisation means the marginal cost of energy will collapse, which again should be beneficial for productivity.
Conclusion
Peter is the only Partner in the research department in Goldmans in Europe – he is very measured with his answers and his research on market cycles is detailed and highly analytical. A few weeks before I interviewed Peter in June, 2024, I had lunch with a seasoned investor and he said you just need to know which phase of the market you are in and then investing is straightforward. I think Peter’s books can really help with that understanding and for any student of market history, they are recommended reading. And if you aren’t a student of financial history, I promise that will make you a better investor.
I concluded our conversation by asking Peter if he had any advice for someone contemplating a career in asset management and he had some really good advice to offer, but you will need to listen to the episode. If you do have anyone thinking about a career in the industry, I have prepared a free course to help. Please take a look at my latest online course – did I mention that it’s FREE?
The Books
The Long Good Buy
Any Happy Returns
Note: These are affiliate links, and the fees are donated to Duchenne UK, the charity supported by the podcast.