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Why the looming bear market will be different

London (CNN Business)When a bear market arrives, it's not pretty, especially for investors making short-term decisions. But it happens — and a recovery arrives eventually.
Quick refresher: A "bear market" refers to when stocks drop 20% or more from their recent peak. They're a sign of extreme negative sentiment on Wall Street and are more severe than garden-variety sell-offs.
Since World War II, the S&P 500 has experienced 17 bear markets or near bear markets, according to an analysis by LPL Financial's Ryan Detrick. Number 18 is all but certain to arrive soon.
The S&P 500 is down 18.7% from its high in early January, battered by concerns about inflation, interest rate hikes and the war in Ukraine. Most traders don't expect it to begin staging a sustained comeback for some time.
"The sour mood has been persistent," Peter Boockvar, chief investment officer at Bleakley Advisory Group, wrote to clients earlier this week.
Historically, when the S&P 500 has entered a bear market, the average drop was almost 30% and went on for nearly a year.
That period is painful, but it doesn't last forever. And importantly, bear markets haven't always been precursors to recessions in the United States.
"In 1987, we had a bear market and no recession, and earnings continued to rise," Edward Yardeni, president of Yardeni Research, told me. "That may very well turn out to be the environment we're in now."
Still, economists and investors acknowledge that the risk of a recession will rise as inflation eats into consumer spending and the Federal Reserve keeps hiking rates in a bid to combat the problem.
"The probabilities have been growing all year long," said Darrell Cronk, president of the Wells Fargo Investment Institute. His team now believes it's more likely than not that the United States economy shrinks later this year and in early 2023, he added.
What happens next? It's easy for every bear market to seem like the end of the world, as nervous traders anxiously eye a sea of red. But to date, every huge bust has been followed by an even bigger rally. It's just a question of when the recovery begins.
This time around, that timing is much harder to predict. Usually, a bear market bottoms out when the Fed decides its work is done and eases policy. But with inflation rising at the fastest clip in decades, the central bank has signaled that it intends to remain hawkish for some time.
"For the sake of its credibility, it has to stay the course here in terms of bringing inflation down," Yardeni said.
In addition to raising rates, the Fed will soon begin the process of selling the bonds it bought in recent years, another mechanism for stimulating the economy. It's never done that for very long before, which makes it harder to discern what the market response will be.
"The only time they've really done that with intent was the end of 2018 and they abruptly and quickly stopped that as growth rolled over in early 2019," Cronk said.
That makes it difficult to find a helpful precedent for the bear market on tap.
"There's not a lot of good models to use," he continued.
May 21, 2022 13:52
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