U.S. Equities Re-Enter Bear Market
On Monday, June 13, 2022, the S&P 500 opened in Bear Market territory. A Bear Market is traditionally defined as a 20% decline from the peak. This is the second time in a little over two years that we have experienced such a decline (COVID sell-off) and the 14th since 1950.
While other markets were already down more than 20%, such as tech stocks, cryptocurrencies, biotech stocks, and all of the Russell growth indices, the broader-based S&P 500 finally fell based on higher-than-expected inflation readings. This past Friday’s May Consumer Price Index inflation reading of an 8.6% annual increase was higher than the expected 8.3% survey reading and the highest print since the economy was exiting the 1970s and 1980s inflationary episode. This latest reading put to end the hope of “peak” inflation occurring in May and hopes of a near-term settling in bond yields, while also setting the stage for more aggressive Federal Reserve action.
While the COVID-induced Bear Market of 2020 was followed by a sharp & abrupt market rebound on the heels of both monetary easing and fiscal stimulus, that will not be the response to this decline. In that case, robust support was provided to offset lost wages in a closed economy. Now, we have an open economy running hot, fueled by previous stimulus, supply chain issues, a tight labor market, and higher commodity prices (exacerbated by the war in Ukraine). In this case, the response will be financial tightening, and that process has just begun.
How long and deep will this Bear Market be? Thus far, the losses have been due to valuation multiple compression (with prices going down but earnings growth remaining firmly positive – therefore, the price paid for a unit of earnings has come down). Market participants generally pay less for a unit of corporate earnings in higher inflationary periods. The worry is that inflation remains stubbornly high, forcing the Federal Reserve to increase interest rates to the point of recession, resulting in lower corporate earnings. However, several of our research firms – such as J.P. Morgan, Oxford Economics and Goldman Sachs, - continue to rate recession risks as low over the next 12 months. Indeed, J.P. Morgan’s top strategist has stated their belief that the markets will eventually rebound back into positive territory by year end – in our view, this is a bit optimistic, but highlights the range of opinions out there. Nevertheless, all eyes will be on inflation and the Federal Reserve’s response over the coming days and months.
Without a “crystal ball,” we can use history as a rough guide of what to expect. The good news is that the losses from bear markets are usually recovered quickly. Twelve-month returns have averaged over 13% for those investors that bought immediately after a 20% decline, with the average rebound in recession periods actually slightly higher over that time horizon (see chart below). There has only been one period over the past 40 years where equities saw a meaningful negative return over the following 12 months of a bear market – in the global financial crisis – and the current environment looks nowhere near as bad as we are far from the brink of a financial crisis.
As famous investor Shelby Davis quoted, “You make most of your money in a bear market, you just don’t realize it at the time.” The importance for keeping an eye on the longer-term is more important than ever in times like these. Money invested in a Bear Market often has the highest rate of return after several years.
In the wake of pronounced downside volatility across risk assets and safe havens alike, broadly diversified portfolios and a patient investment discipline remain of paramount importance, as markets will likely continue to be volatile as market participants seek clarity. For more general information on Bear Markets and current economic conditions, Legacy is in the process of developing our quarterly education piece on just that. This will be released in July.
Legacy Trust Family Wealth Offices
4200 Marsh Landing Blvd, Suite 100
Jacksonville Beach, FL 32250
Office: (904) 280-9100
Fax: (904) 280-9109
Legacy Trust Family Wealth Offices of Jacksonville Beach, Florida, is a new type of financial services firm - an independent multi-family office - that brings all facets of your personal financial affairs under one roof, where they are coordinated for optimum efficiency and maximum performance.
Investment products are not FDIC insured, are not bank guaranteed, and may lose value.