How Low Can This Market Go? The 40 Percent Solution

Includes: IVV, IYW, SPY, XLF, XLI
by: Roger Nusbaum

Long time reader JackS left a comment noting that the average bear market decline is 34.1% (I thought it was closer to 30%) but that because the financial sector is at the heart of this bear market it could mean a 40% decline before we are done.

There are people who share JackS' concern with regard to magnitude. I have not yet moved off of my normal bear idea yet, I can see where it might fall apart but for now I continue to believe it will be within the range of normal.

As I read the comment I started to think about the sector weightings of the S&P 500 which are as follows, according to the iShares page for its S&P 500 fund which trades under ticker IVV.

  • Tech 16.37%
  • Energy 15.18%
  • Financials 14.07%
  • Healthcare 12.51%
  • Staples 11.30%
  • Industrials 11.19%
  • Discretionary 8.11%
  • Utilities 4.08%
  • Materials 3.72%
  • Telecom 3.26%

A 40% decline from the top, 1565, would take the S&P 500 down to 939.

In the decline thus far, financials have gone from 21% or so down to 14%. How much further can the sector fall? Since the market's peak in October, so not the sector's peak, the financials as measured by Financial Sector SPDR (NYSEARCA:XLF) is down 45%. So a 45% decline has worked out to a 1/3 less weighting in the index.

Again, how much further can it realistically fall? Don't confuse my asking the question with a belief that a bottom is in, but what is a reasonable expectation? If XLF were to fall by another 1/3 from here (which I think is more than will actually happen) that might work out to another 5% that comes out of the S&P 500, using simple math.

Both tech, measured by client holding iShares Technology (NYSEARCA:IYW), and industrials, as measured by Industrial Sector SPDR (NYSEARCA:XLI), are down the same, 20%, as the S&P 500 since last October but their weightings have inched up some, tech moreso than industrials, because of the massive underperformance of the financials.

IYW topped out at the beginning of the decade near $136 versus $52 today. How much further can it fall? Based on how this bear market has shaken out, is it likely that it could start to fall much more than the rate of the market? Again the tech decline has been in lockstep so something would need to change for tech to start falling faster.

Despite General Electric (NYSE:GE)'s having fallen from $42 down to $27-ish, it still makes up16% of XLI so it has contributed a disproportionately large portion to the 20% decline of the sector. How likely is it the another 34% comes out of GE? If anything, the rest of the sector might catch up to GE.

What about energy? Not surprisingly, its weight has grown over the years and the notion that energy could correct is gaining some traction. I would not argue that the price appreciation has overstated how quickly supply and demand for oil is changing, but energy cutting in half relative to the S&P 500 after peaking out at only a 16 or 17% weight would be very odd.

Staples should do well in a bear environment and they have done well so I'm not too worried about them taking down the market. Healthcare, while it has not done as well as you'd think,  is doing better than the broad market and a catalyst for more declines emanating from here also seems unlikely. The smaller sectors could implode inward like a supernova without doing a lot of broad market damage.

The point here is not that the market has bottomed or that 40% can't happen, but going sector by sector a lot of things would have to come together to create quite a storm for the decline thus far to only be the halfway mark.

A lot of things are down a lot and here we are down 20% for the broad market. A second decline of 40% or more within the same decade seems like a huge obstacle. It did happen during the 1930s. The high for the Dow was 381 in 1929. A low was put in in 1932 at 59. The ensuing rally topped out in 1937 at 194. The market then bottomed out again at 92 in 1942.

So is this decade really as bad as the depression followed by World War II?