Anatomy of a Bear Market | Stock Market Index | S&P 500 Index

Anatomy of a bear market

A bear is a bear is a bear, right? That may depend on how you look at it.
Timothy M. Koller and Zane D. Williams


hough global stock markets seemed to

enter autumn showing signs of a new resilience, it would take a dramatic late turnaround to keep 2002 from marking the third consecutive year of decline in the S&P 500 index. Indeed, by most typical measures the worst bear market since the Great Depression took the index down 37 percent from January 2000 through October 2002, savaging portfolios and the retirement accounts of millions of investors. But make a closer examination of this difficult market and the bear’s contours might surprise you. For example, as the S&P was plunging, were individual company stocks following suit? Not exactly. The fact is that over 40 percent of the companies in the index actually saw their share price increase during this bear market (Exhibit 1). Indeed, while the overall index plummeted the share prices of over 50 percent of S&P 500 companies either increased in value or declined by less than 10 percent. The market’s damage to investors may have been all too real, but clearly, it is a bear of a different color when only half of stocks decline more than 10 percent. So how healthy is the market now? We make no forecasts, but working from some additional facts and insights it is possible to view the market’s decline as more narrowly based than broad based and to find some historical reassurance that much of its excess has been wrung out.

Exhibit 1. Forty-one percent of S&P 500 have had positive returns
Shareholder returns1 Percent of S&P 500 Ͼ 50% 40% to 50% 30% to 40% 20% to 30% 10% to 20% 0% to 10% 0% to Ϫ10% Ϫ10% to Ϫ20% Ϫ20% to Ϫ30% Ϫ30% to Ϫ40% Ϫ40% to Ϫ50% Ͻ Ϫ50%

1% 0% 2% 41% 5% 16% 17% 19% 13% 8% 5% 5% 7%

Jan 1, 2000 to Oct 31, 2002 Does not add up to 100% due to rounding

Source: Compustat, McKinsey analysis

A one-two punch
For starters, a sector-by-sector analysis shows that the market’s travails appear to have been highly concentrated in two areas, information technology and telecommunications. Technology and Telecom are down 64 and 60 percent, respectively, but across the broad economy all other sectors are either up or down only slightly (Exhibit 2).

6 | McKinsey on Finance Winter 2003

2000—Sept 30. the bear market has delivered a large correction in the values of these very large companies (Exhibit 3).Exhibit 2. however.1 Before the 1998 emergence of a market bubble. the S&P 500 was designed as a value-weighted index in which each stock’s market value determines its weighting. The two-year market bubble saw the emergence of megacapitalized stocks. which are those stocks whose companies’ market capitalization surpassed $50 billion during that period. A second factor that shaped this bear market and the way it was perceived was the performance of the largest companies in the index. percent Number of companies >$50 –37 49 $25–$50 –33 46 $10–25 68 75 37 10 36 500 Total Sample <$5 –19 110 $5–$10 4 138 23 157 –3 500 Source: Compustat. they had grown to represent 45 percent of the market. To serve as a better reflection of the underlying economy and its most important business sectors. Largest companies have had worst returns Average returns. 2000—Oct 31. technology and telecom stocks typically represented 15 to 25 percent of the S&P index’s overall market capitalization. McKinsey analysis The brutal correction in the values of many companies in these two sectors may well bring them back to more realistic levels after a period of overvaluation. Bubble sectors have performed the worst Average returns. The result reflects more of a market aggregate than an average. These megacapitalized stocks were largely responsible for the distortion of market averages. Jan 1. As with the technology and telecom sectors. 2002 Sector Consumer discretionary Consumer staples Energy Financials Health Care Industrials Information technology Materials Telecom Utilities Overall sample Source: Compustat. But we do believe it is unlikely that these sectors will continue to see big swings in market value. They have since pulled back within their historical range. Anatomy of a bear market | 7 . Jan 1. 2002 Market cap $ Billions Returns. to a level just below their pre-bubble average. one in which the largest companies have the biggest impact on the index. By 2000. Has the market overcorrected in these sectors? We cannot say. percent 4 21 Number of companies 87 34 25 75 29 44 Exhibit 3. McKinsey analysis –3 –60 2 –64 –10 7 12 19 Returns.

5 Jan 2000 Mar 2000 May 2000 Jul 2000 Sep 2000 Nov 2000 Jan 2001 Mar 2001 May 2001 Jul 2001 Sep 2001 Nov 2001 Jan 2002 Mar 2002 May 2002 Jul 2002 Sep 2002 Source: Compustat. Are S&P 500 P/E ratios back to normal? 30 25 20 S&P 500 Overall 15 10 Median S&P 500 company 5 0 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 YTD Source: Compustat.3 1.1 Median return 1.Exhibit 4. How much has the market fallen? 1. McKinsey analysis Exhibit 5.7 0.4 Unweighted return 1.8 0. McKinsey analysis 8 | McKinsey on Finance Winter 2003 .6 0.2 1.9 0.0 S&P 500 0.

com) is a principal in McKinsey’s New York office. despite the real pain it inflicted on investors.One effect: while the performance of most companies may continue to hum along. 2000—Sept 30. “What happened to the bull market?” McKinsey on Finance. Only 2 percentage points are due to the other 378 companies in the index (Exhibit 6). Copyright © 2003 McKinsey & Company. (Exhibit 4). however. there may be grounds for reassurance that much of the market’s excesses appear to have been wrung out. Indeed. And if the bear market. D.with market technology munications caps above sector sector $50 bn All other companies Total –21 –4 –10 –2 Number of companies –37 77 12 33 378 500 Market cap weight at 27% beginning of period 7% 35% 31% Source: Compustat. Koller and Zane D. Today.C. represents more the bursting of a sector bubble than the outgrowth of broad economic weakness. a logical development since they don’t grow faster over the longer is an associate in the Washington. To quantify the impact of the various factors that contributed to the S&P’s decline. Number 1. In fact. in the end the market may demonstrate that it is not ailing as badly as it has seemed to be. McKinsey analysis Forward to the past? From an historical perspective. there has been little difference in the end result when the S&P’s performance is measured as a weighted index. This means that larger capitalization companies have lost their bull-market premium over the rest of the market. 25 percentage points of the market’s 37 percent decline can be attributed to IT and telecommunications companies. Another 10 percentage points can be assigned to the decline of very large cap stocks. which is still struggling to recover from the high-tech bubble and downturn in megacap stocks. percent Companies Information Telecom. Exhibit 6. or as the result of tracking the median company. alternative measures of the S&P 500’s performance produce a distinctly less dramatic picture of its bear market fall. office. 2002. Summer 2001. 1 Timothy M. Jan 1. MoF Tim Koller (Tim_Koller@McKinsey. Historically. Anatomy of a bear market | 9 . The overall result Shareholder returns. using either alternative measure produces a picture of an S&P500 that declined little during the bear market. All rights reser ved. in which each company has the same weight regardless of size. Zane Williams (Zane_Williams@McKinsey. for example. the overall valuation level of the market is in line with history and a review of the market’s price to earnings (P/E) levels over the past 40 years suggests that the gap between the P/E of the official S&P 500 and the median P/E mostly dissipated (Exhibit 5). as an unweighted average. Williams. general perceptions of the market have been shaped by the weighting of the index.

com Dennis Swinford Michelle Soudier Joan Horr vich Kim Bar tko Copyright © 2003 McKinsey & Company. Bill Javetski. All rights reser ved. Dennis Swinford McKinsey_on_Finance@McKinsey.corporatefinance. No par t of this publication may be copied or redistributed in any form without the prior written consent of McKinsey & Company.McKinsey on Finance is a quar terly publication written by exper ts and practitioners in McKinsey & Company’s Corporate Finance & Strategy Practice. © EyeWire Collection. Jason Reed/PhotoDisc. Michelle Soudier. . Cover images. Editorial Board: Editorial Contact: Editor: Managing Editor: External Relations: Design and Layout: Marc Goedhar t. © Rob Colvin/Ar McKinsey & Company is an international management consulting firm ser ving corporate and government institutions from 85 of fices in 44 countries. left to right: © Rob Colvin/Ar tville. It offers readers insights into value-creating strategies and the translation of those strategies into stock market performance. © Ar t © EyeWire Collection This publication is not intended to be used as the basis for trading in the shares of any company or under taking any other complex or significant financial transaction without consulting with appropriate professional advisers. This and archive issues of McKinsey on Finance are available on line at http://www. Timothy Koller.

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