What A Bear Market Means For The Economy

ItYou can expect anxiety-inducing rides if you are a shareholder of pandemic-era gains in the stock exchange or have a plan that allows for 401(k). For the first time in nearly two years, the stock market crossed into bear market territory this week as inflationary concerns have sent the S&P 500 spiraling down more than 20% from its record high in early January.

This grim moment marks another bottom for Wall Street. Wall Street has been plagued by sharp stock market declines in recent months. On Monday, the S&P 500 tumbled nearly 4% as all but five of its components ended the day with losses. Stocks continued to fall on Tuesday but turned upward following Wednesday’s Federal Reserve meeting, where policymakers raised interest rates by three quarters in a continued effort to fight inflation.

It’s unknown how long the bear market will last, but historical examples can shed some light on what to expect. Here’s what you need to know.

What exactly is a bear-market?

Wall Street uses the “bear market” term to describe a sustained period when the equity markets are down at least 20% from their recent peaks. Passing the 20% threshold—which occurred on Monday for the S&P 500 index—typically indicates widespread pessimism about the health of the U.S. economy and negative investor sentiment.

These steep downturns have been rare. They’ve only happened 14 times, not including this one. LPL Research found that stock prices dropped for 19 months on average after bear markets. Some take longer. The last bear market carried on for only 33 days, from mid-February to late March of 2020, at the start of the Covid-19 pandemic—the shortest bear market since World War II.

The most recent sustained bear market lasted 17 months, beginning in 2007 at the start of the financial crisis, and resulted in the S&P 500 dropping by 51.9%. A second sustained bear market was created in 2000 after the burst of dot-com, which caused many tech companies to fail. The bear market lasted for about two years.

But in order for a bear market to end in relative quick fashion–like it did in 2020–there needs to be some sort of catalyst to get investors excited about stocks again, says Emily Bowersock Hill, chief executive of Bowersock Capital Partners, a financial management firm. The cryptocurrency market and meme stocks were all there for investors during the bear market. This time, it’s a little less clear. “To turn this sentiment around and have a real recovery in this bear market,” Hill says, “we’re either going to need to see some surprisingly good earnings, which I think is quite unlikely, or would need some kind of improvement in the conflict between Russia and Ukraine, which I would consider equally unlikely.”

What is the secret to our success?

The stock market experienced double-digit returns in the aftermath of the pandemic. However, it took a dramatic turn in the early 2022 when the economy had to deal with record inflation, supply chain disruptions, war in Ukraine and rising interest rates. All these factors increased investor anxiety and led to the bear markets.

In an effort to control inflation, which is at its highest level in over 40 years due to rising energy and food prices, the Federal Reserve increased interest rates for only the second time since 2018. These aggressive Fed moves tend to cause investors anxiety because they make borrowing more costly for businesses and households. It can also stifle growth and possibly lead to recession. The bear market was also triggered by Friday’s higher than expected inflation report, which raised concerns that the Fed might raise interest rates more aggressively in the coming year.

But Wall Street had been expecting this moment for some time, so it came as no surprise to market watchers and analysts that the S&P 500 dropped more than 20% on Monday since its peak.

Do the U.S. and Europe face a crisis?

Bear markets don’t always lead to recession, but they can be an indicator that one is coming. You can use them to forecast other economic signals such as the yields of treasury bonds or stagflation. This is when economic growth falls while prices go up.

But it’s complicated. There are many opinions among market watchers about whether or not the economy is heading for recession. Many believe it is impossible for recession to begin when unemployment has fallen to its lowest level and the economy continues to grow. Others think a recession is inevitable, especially as Russia’s invasion of Ukraine wages on and inflation continues to rise.

“The only way to stop inflation is to reduce demand and make the labor market less tight,” says Victoria Greene, chief investment officer at G Squared Private Wealth. But even if that happens, and consumers cut back on their spending habits, it could have a trickle down effect on the economy and result in employee layoffs—all signs of recession. “Consumers are already buying less electronics and home goods and buying more staple goods,” Greene adds. “The U.S. economy lives and dies with the consumer, so if spending slows, that could lead to a recession.”

What can investors do to make it a success?

Hill suggests that investors may be tempted to withdraw their capital from the stock exchange to reduce losses. However, Hill believes this is not the best strategy. Investors have always found bear markets a good time to build wealth long-term because stock prices are low.

“You could sell now and probably save yourself some short term pain,” Greene says, “but you risk missing out when the market turns around and you’re buying back at a higher price.”

Hill agrees. “If you’ve got a lot of cash, start gradually putting that money to work while stock prices are low,” she says. “You could be in an even better position a few years from now.”

However, this may not work well for everybody. In a volatile market like this, it is important to understand your needs. For instance, if they are retired and have spending needs or need money for rent, it’s imperative to have some sort of savings set aside for 12 to 18 months of cash flow, Greene says. Stock markets do tend to improve over the long term, with the S&P 500’s returns over the past five years still around 70% when including dividends, but it may take three years or longer coming out of a bear market.

It’s also important for investors to look closely at the kinds of companies they are investing in since some will be higher risk, such as small caps which have no earnings, because of the volatility and possibility of a recession.

“I’m advising clients to hunker down and be prepared,” Hill says. “Don’t overreact, but this could well be one of the longer bear markets that we’ve experienced since 2000.”

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