With stock prices down sharply last week the words ābear marketā and ācorrectionā have once again been bandied about.Ā In response, I first offer the standard definition of both terms and then a warning.Ā A ācorrectionā is defined as a drop of 10% or more in major indexes like the S&P 500 from previous highs.Ā It is called a ābear marketā if the drop is more than 20%.
As properly defined, both corrections and bear markets are ex post concepts ā they say nothing about the future.Ā Too frequently both terms get misinterpreted.Ā People say we are āin a bear marketā as if that means that prices are more likely to fall than rise in the near future.Ā In fact, there is no such predictive content.Ā To the extent that past recent drops in prices predict anything, it is that future prices are slightly more likely to rise.Ā However, the effect is so small as to be of no practical importance.Ā The warning is that if you hear people talking about bear markets, listen carefully.Ā They may not know what they are talking about.
Bradford Cornell is an emeritus Professor of Financial Economics at the Anderson School of Management at UCLA. Prof. Cornell has taught courses on Applied Corporate Finance, Investment Banking, and Corporate Valuation. He is currently developing a new course on Energy, Climate Change and Finance. Professor Cornell received his Masters degree in Statistics and his PhD in Financial Economics from Stanford University. In his academic capacity, Professor Cornell has published more than 125 articles on a wide variety of topics in applied finance, particularly empirical analysis of asset pricing models. He is also the author of Corporate Valuation: Tools for Effective Appraisal and Decision Making, published by Business One Irwin, The Equity Risk Premium and the Long-Run Future of the Stock Market, published by John Wiley and Conceptual Foundations of Investing published by John Wiley. He is a past Director and Vice-President of the Western Finance Association and a past Director of the American Finance Association. As a consultant, Professor Cornell has provided testimony and expert analysis in some of the largest and most widely publicized finance related cases in the United States. Among his clients are AT&T, Berkshire Hathaway, Bristol-Myers, Citigroup, Credit Suisse, General Motors, Goldman Sachs, Merck, Microsoft, Morgan Stanley, PG&E, Price Waterhouse, Verizon, Walt Disney and various agencies of the United States Government. Professor Cornell is also a senior advisor to Rayliant Global Investors and to the Cornell Capital Group. In both capacities, he provides advice on fundamental investment valuation. In his free time Prof. Cornell enjoys cycling and golf.
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