Blog: Correction or Bear Market-The quantification of jargon

When I first entered the investment business in 1978, the use of quantitative techniques was the lunatic fringe of investing. Those of us who used these methods wanted to change the world, and we did. Now, even “traditional” managers use what would have been considered quant techniques in the 1970s and 1980s.

One of the by-products of analytical methods becoming mainstream has been the quantification of jargon that had already been in the investing world for over 150 years. This struck me with this year’s market sell-off. In early January, Reuters proclaimed “NASDAQ confirms fourth correction since pandemic hit.” About the same time, Bloomberg said that China was in “striking distance” of a bear market. In the former article, a correction was defined as a 10% decline, while in the latter a bear market was a 20% decline. But these precise trigger points didn’t exist until the 1990s. Prior to that, any prolonged downturn in the market was considered a “bear market.” A shorter drop in prices was a “correction.” One rule of thumb was that a bear market was about 6 months or longer, while a correction was a couple of weeks. Accordingly, a “bull market” used to be any extended rally but is now classified as a 20% rise to mirror the bear market definition.

It’s likely that in the 1990s, more precise definitions began showing up largely so that academics and Wall Street analysts could study market characteristics and have a common language to share research. As data became more easily available and computers more powerful, quant research exploded. Why 20% and 10% became trigger levels is not really known, nor is there any magic in those particular numbers. The temporal part of the jargon appears to have been dropped altogether. Now, a 20% downturn of any length is a “bear market,” perhaps so that researchers have more examples to study.

I bring this up because the media will often say that if the market fell by less than 20%, something negative was averted and we should all breathe a sigh of relief. Unfortunately, I don’t believe that a 19% decline feels a lot better than a 20% decline. These pronouncements of bull and bear markets, as well as corrections, should be taken with a lot of grains of salt. They’re not really that meaningful in and of themselves. They are, in fact, arbitrary definitions that help the industry communicate with itself. But that’s about it. The underlying cause of the decline or rally is much more important than arbitrary thresholds.

Reprinted from the First Quadrant "Brim Shots" blog.