The S&P 500 is teetering on the edge, nearly reaching a 20% drop from its high on February 19. In financial circles, that kind of drop is often dubbed a “bear market.” But where did this 20% figure come from, anyway? And for that matter, why is a 10% drop called a “correction”? You might think it was a decision made by a council of Wall Street gurus, but that’s not the case. The concept of categorizing declines—with 10% to 20% as a “correction” and 20% or more as a “bear market”—can largely be credited to one man: Alan Shaw. Shaw was a pioneering figure in technical analysis, co-founding the Market Technicians Association (now the Chartered Market Technician Association) and leading the technical research team at Smith Barney. Before he retired in 2000, Shaw had already solidified a straightforward method to describe market downturns.
“Alan wanted to keep things simple,” Louise Yamada explained to me. She joined Alan in 1980, well after he had crafted his now-fundamental framework. “He’d say any drop up to 10% is a consolidation, 10% to 20% is a correction, and anything beyond 20% is a bear market,” she recounted. After Shaw’s retirement, Yamada took over the technical analysis duties at Smith Barney before eventually setting up her own firm in 2005. While other analysts have their takes on what defines a bear market, Shaw’s terms for market declines struck a chord with the public. “The simplicity makes it easy to remember,” Yamada noted.
One key point everyone agrees on when identifying a 20% market decline is that it’s determined by closing prices, not intraday fluctuations. According to S&P Dow Jones Indices, the record high for the S&P 500 was on February 19, when it closed at 6,144.15. For a 20% dip, the index would need to close at 4,915.32. Importantly, hitting or dropping below that mark doesn’t initiate the bear market. The bear market officially begins from the date of the peak, February 19. “A bear market starts with the first downtick after the final peak,” Tom McClellan, editor of The McClellan Market Report, explained to me. “It’s not about hitting a 20% decline; the whole downturn is the ‘bear market territory.'” This perspective is echoed by S&P Dow Jones Indices, which stated: “If the index closes at or below 4,915.32, February 19 will mark the end of the bull market and the start of the bear.”
Looking ahead, McClellan offered some insight: “Saying we’re down 20% doesn’t predict the future,” he cautioned. His advice? “Follow the trend unless there’s a strong reason to buck it.” As McClellan observed, “We’ve been in a downtrend, but we’re so oversold that a bounce feels likely.” And what happens after a bounce? “Then you assess its strength,” he said.
Although Alan Shaw passed away several years ago, Louise Yamada continues to impart her knowledge on technical analysis, and she remains cautious about declaring a market bottom. “We’re all watching for a Bear Market Rally,” Yamada explained, referring to a rally of at least 10% following a 20% market decline. “After this, the market might hit a new low,” she warned, hinting at the potential for further declines. Reflecting on market history, Yamada shared that the S&P 500’s average bear market rally, from 1929 to 2020, is around 18% over 31 trading days.
