The Bear Market Probability can be more technically described as the probability of a bear market given the yield curve ("P[BM|YC]"). Additionally, we define the Bear Market Probability as the chance of a Stock Market decline that is 20% or greater over the next 24 months. We also define the Yield Curve here as a comparison of the federal funds and 10 year treasury rates. Let's explore deeper on how the Bear Market Probability is calculated by examining the sources of data and describing the statistical computations.
The Yield Curve
At the end of each month, and as far back as 1959, we collect the 10 year treasury rate from the U.S Treasury's website. During this same time, we acquire the end of month federal funds rate from the New York Federal Reserve's website. Dividing the federal funds rate by the 10 year treasury rate gives us a measurement that we call the Yield Curve and is used as the independent variable of our analysis of Stock Market return.
The Stock Market Return
Using our Stock Price API, we collect S&P 500 monthly returns. From this data we calculate each monthly observation's minimum logarithmic return over the next 24 months of that observation. This is different from the normal measure of a return in that usual methods look backwards in time by taking the subject's value and comparing it to an observation in the past - whereas our calculation takes the subject's value and compares it to a future observation. We take this forward looking approach as we are interested in how the Stock Market behaves in the future given the interest rate environment at a given point in time. This result is used as the dependent variable within our analysis and we refer to it as the Stock Market Return.
Building the Data Map
We round the data in an effort to consolidate it into measurable groups and for the ease of the analysis. The Yield Curve data is rounded to the nearest 0.05 and Stock Market Return data is rounded to the nearest 0.01. Using the Yield Curve rounded data as the X axis and the Stock Market Return rounded data as the Y axis, each time paired monthly observation is counted in the Data Map. This results in a table of counts, or histograms, of Stock Market Return relative to the given Yield Curve group. Appended to the last row and the last column of the Data Map is the summation of frequencies of each row and column respectively.
Probability of a Return (Prior)
Using the Data Map, we can calculate the probability of a given Stock Market Return or group of returns, by summing the frequency range of the returns (sum of rows in the Data Map) and dividing by the total number of observations. For the probability of a bear market ("P[BM]"), we use the standard bear market definition of a decline of 20% or greater. This calculation is called the Prior in the Bayesian Inference method and represents the unconditional probability of our dependent variable.
Probability of the Yield Curve (Marginal Likelihood)
The probability of each rounded Yield Curve's ("P[YC]") group (in 0.05 increments) is calculated by dividing the Yield Curve group's total frequency (sum of the subject column) and dividing by the total number of observations. This probability is referred to as the Marginal Likelihood in Bayesian terms and is the unconditional probability of our independent variable.
The Probability of Yield Curve Given Bear Market (Likelihood)
The probability of a Yield Curve group given the observed Bear Market stock market return ("P[YC|BM]") is calculated by dividing the sum of the Yield Curve group's Bear Market Return frequency by the sum of the Bear Market Return rows summations (sum of sums). Bayesian statistics refers to this as the Likelihood.
The Probability of Bear Market Given Yield Curve (Posterior)
The probability of a Bear Market given the Yield Curve group ("P[BM|YC]") is calculated by dividing the product of the probability of a bear market ("P[BM]") and the probability of the Yield Curve given Bear Market ("P[YC|BM") by the probability of Yield Curve ("P[YC]"). This final calculation is the Posterior in Bayesian Inference ("P[BM|YC]=P[YC|BM]*P[BM]/P[YC]"). From this point, we are able to assess probabilities of Bear Markets based on their past experiences against the Yield Curve's behavior.
Polynomial Regression
We derive a set of probabilities by extending the Bayesian Inference calculation to the range of Yield Curve groups. In an effort to smooth out this data, we then take a 3rd order polynomial regression of the set of probabilities as the final equation to estimate the Bear Market Probability. The model thus gives us a fair estimate of the probability of a Bear Market provided by how the Yield Curve behaves.
FAQs
The Bear Market Probability can be more technically described as the probability of a bear market given the yield curve ("P[BM|YC]"). Additionally, we define the Bear Market Probability as the chance of a Stock Market decline that is 20% or greater over the next 24 months.
What is the best indicator for the bear market? ›
Here are two key technical indicators used to recognize bear markets: Moving Averages: Moving averages are widely used in technical analysis to smoothen price data and identify trends. The 200-day moving average is a common indicator used to determine the long-term trend of a stock or market index.
How long will this bear market last? ›
But one positive trend when it comes to previous bull and bear markets it that the good times generally last far longer than the bad. The median length among bull markets since 1929 is 522 days, according to the Bespoke data, while the median bear market lasts just 240 days.
Should I sell my stocks in a bear market? ›
It's common knowledge that the main goal of investing is to buy low and sell high, but by reacting emotionally to market swings, you're literally doing the opposite. Invest in stocks that you want to own for the long run, and don't sell them simply because their prices went down in a bear market.
What percentage of Americans have no money in the stock market? ›
According to a recent GOBankingRates survey, almost half of the survey's participants reported not owning any stocks, with 22% having less than $15,000 in total stock investments.
What is a good probability index? ›
What Is a Good Profitability Index? Generally, the higher the PI the better. A profitability index greater than 1.0 is often considered to be a good investment, as it means that the expected return is higher than the initial investment. When making comparisons, the project with the highest PI may be the best option.
Should you buy or sell in a bear market? ›
The bottom line
When a bear strikes, you can see share prices falling hard and market values getting lower. Mentally, this may trigger your sense to "buy low," which is generally a smart thing to do.
What stocks do well during bear market? ›
Defensive stock sectors including consumer staples, utilities, and health care tend to outperform during bear markets. Government bonds offer important diversification benefits and the potential of strong returns in a recession.
Should I buy gold in a bear market? ›
It's also generally expected to hold up in so-called “risk off” markets, when investors tend to flee from riskier fare, like stocks, into perceived safe-haven assets, including gold and bonds. That means investors tend to pick up more gold in the lead-up to and during recessions and bear markets.
Should I pull my money out of the stock market? ›
It can be nerve-wracking to watch your portfolio consistently drop during bear market periods. After all, nobody likes losing money; that goes against the whole purpose of investing. However, pulling your money out of the stock market during down periods can often do more harm than good in the long term.
There are no set ages to get into or to get out of the stock market. While older clients may want to reduce their investing risk as they age, this doesn't necessarily mean they should be totally out of the stock market.
How long did it take for the stock market to recover after 2008? ›
The bounce-back from the 2008 crash took five and a half years, but an additional half year to regain your purchasing power.
What is the 3-5-7 rule in trading? ›
The 3–5–7 rule in trading is a risk management principle that suggests allocating a certain percentage of your trading capital to different trades based on their risk levels. Here's how it typically works: 3% Rule: This suggests risking no more than 3% of your trading capital on any single trade.
How much cash should I have in a bear market? ›
By reducing the market exposure to 80% with a 20% cash position, the same market loss results in a portfolio loss of only 8%. It gives you peace of mind, which can reduce the chances of panic selling when the market is volatile.
What is the 10 am rule in stock trading? ›
Some traders follow something called the "10 a.m. rule." The stock market opens for trading at 9:30 a.m., and the time between 9:30 a.m. and 10 a.m. often has significant trading volume. Traders that follow the 10 a.m. rule think a stock's price trajectory is relatively set for the day by the end of that half-hour.
What is the Warren Buffett Index? ›
The Buffett Indicator (aka, Buffett Index, or Buffett Ratio) is the ratio of the total United States stock market to GDP. Buffett Indicator = Total US Stock Market Value Gross Domestic Product (GDP)
What is the Buffett Indicator index? ›
The Market Cap to GDP Ratio (also known as the Buffett Indicator) is a measure of the total value of all publicly-traded stocks in a country, divided by that country's Gross Domestic Product (GDP).
Is the S&P 500 currently in a bear market? ›
It's no secret that we're in a new bull market. Investors have enjoyed soaring stock prices as the S&P 500 (^GSPC 0.12%) has climbed by more than 46% from its lowest point in late 2022. But now that we're over a year-and-a-half into this bull market, some investors may be wondering just how much longer it might last.
What is the sentiment of the bull bear index? ›
The bull/bear index reflects the aggregate sentiments of financial advisors and planners who deal daily with the market. It reflects how well-informed professionals feel about the stock market and how they likely advise their clients to invest based on those feelings.
