A Bear Market....Why are we here, a historical perspective, and when will it end?

Jill Green |
Categories

 

Click the video above for a Market Update from Matt Ahrens, CIO and Tony Moeller, CEO.

Why are we here?

During the great recession due the housing collapse, from October 2007 to March of 2009, the Federal Reserve lowered interest rates dramatically and kept them at historic lows until 2017. When COVID hit in early 2020, the Federal Reserve again lowered interest rates to historic lows, and an unprecedented amount of money was injected into the economy via government stimulus efforts.

The combination of both resulted in an overheated economy. With 30% more money in the U.S. economy, along with the hangover effects from COVID (i.e., supply chain issues and labor shortages), the perfect environment for inflation began to arrive. When it did arrive in 2022, the Russian invasion of Ukraine only exasperated that problem with higher natural gas and gasoline prices.

Sadly, much of this could have been avoided if the Federal Reserve had raised interest rates much sooner, say early 2021, when it was obvious that the U.S. economy had overcome some of the negative economic impacts of COVID. At that time, unemployment rates hit the lowest levels in 50 years and the U.S. stock market continued to hit new highs. Unfortunately, the Federal Reserve took no action, and the result was too much money chasing a limited amount of goods.

A good example of inflation is illustrated in these next three slides.

In slide one, it is assumed that the U.S. money supply is the equivalent of $10 and the economic output is represented by 10 apples. In this case, each apple is worth $1.

In slide two, we now see the impact of an additional 30% or $3 being added to the U.S. money supply, and economic output remains at 10 apples. As a result, each apple is worth $1.30.

 

 

In slide three, we continue with the same money supply assumption as in slide two. However, due to supply chain issues and labor shortages, the economy is only able to produce 5 apples. Now each apple is worth $2.60.

As we have seen over the last year or so, housing and cars have been limited in supply and their prices has jumped dramatically. Going to the grocery store or gas station has been painful, as prices have reached levels not seen in years.

The concern is if inflation is not contained, then we could see a return of stagflation, which occurred in the 1970s. This is a combination of stagnant economy and high inflation, which wreaked havoc on the economy and stock market. To combat this, you must reduce the amount of money in the U.S. and/or decrease demand for goods and services. This is exactly what the Federal Reserve is trying to do by raising rates, and it is already having its intended effects.

It is obvious that the Federal Reserve waited too long to raise rates and we are now paying the price through extremely aggressive interest rate increases. The average rate for a 30-year mortgage has gone from 3.0% at the beginning of this year to approximately 7%.

However, the concern is that the Federal Reserve will overdo the rate increases and plunge the U.S. into a recession, or what has become known as a hard landing. We have seen the stock market react to this possibility and as of the close of the market at the end of September, the S&P 500 is down about 24% from its high in January.

A historical perspective on bear markets

The stock market is a leading indicator of what is anticipated to take place in the economy. It usually trends 6 to 9 months ahead of the economy. As such, the S&P 500, along with the Dow Jones and NASDAQ began declining in January of this year, while the economy seemed to still be accelerating.

The first slide shows that the stock market is quite resilient when facing uncertainty and major crises. From January of 2007 through December of 2021, there has been a myriad of crises and negative events that have occurred. However, the S&P 500 has been able to climb a wall of worry and produce a nice double digit return over that period.

The second slide covers the same period of time but shows how much the market varies during the course of a year. The blue represents where the S&P 500 ended the year, whereas the orange represents the low during a given year. Over this 42-year period, the S&P 500 ended the year in the negative only 9 times, or 21.42% of the time. Furthermore, in four of those years, the negative returns were single digits.

The third slide compares bull and bear markets over an extended period. The bull markets are in blue whereas bear markets are in orange. Since January of 1942 through December of 2021, the S&P 500 has endured 15 bull markets and 13 bull markets.

One could say that bull markets are like riding an escalator (slowly going upward), whereas bear markets are like descending on a high-speed elevator (dropping quickly and steeply). However, there is more than meets the eye when you look at the facts surrounding them.

During this period, the average bull market lasted 4.4 years while the average bear market lasted 11.3 months. Simply stated, over 80% of the time the S&P 500 was in bull market territory and only 20% of the time was in bear market territory.

The final slide illustrates the probability of positive returns over the long run 1937 – 2021. You’ll see that on a daily basis, the odds mimic a flip of the coin on whether the market will be positive or negative. However, as the sample size increases, the odds are overwhelmingly in investors’ favor.

When will the bear market end?

Unfortunately, no one knows the exact date. What we do know is that the bear market will likely end once the Federal Reserve believes it has accomplished its goal of addressing inflation and voices that opinion by stopping their raise of interest rates. Once this occurs, Wall Street will breathe a sigh of relief and begin looking for positive news. Remember the stock market is a leading indicator of the economy, often by about a 6-to-9-month time frame. Thus, the stock market may begin to climb and begin a new bull market while the economy continues to be mired in a recession.

As legendary investor Jim Rogers noted, “The last leg of a bull market ends in hysteria; the last leg of a bear market always ends in panic.” We saw the bull market end in January of this year during a peak of economic good times following the pandemic. We also experienced a nasty but short-lived bear market in early 2020 at the onset of COVID.

At this current point of the bear market, we do believe we are closer to a market bottom than a top. It has certainly been an uncomfortable time period as we have now entered our 9th month in bear territory. Based upon history, a bull market may be several months off, but the rewards should be much greater than the declines incurred.

I hope this analysis gives some perspective on what has occurred in the economy and stock market, and also has shed a light on why the Federal Reserve has made the decisions it has made. Without diminishing the frustrations felt by investors, bear markets are a natural occurrence and expected. The investors who showcase discipline and ride out bear markets with a diversified portfolio will reap much greater rewards when the next bull market begins.

If you have any questions regarding your portfolio, feel free to call us and we will be happy to address them.