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September 26, 2022

Get Ready for the Bear Market

Michael J. Donoghue
Get Ready for the Bear Market

Last week’s selloff was brutal for investors in the US stock market: the Dow Jones Industrial Average closed at its lowest level since late 2020, falling to 29590.41, losing 1.6% on Friday alone. With the S&P 500 currently down a whopping 23% from January’s highs this year, and other indexes close behind percentagewise, stock market bulls are understandably desperate to find any event to warrant optimism. Unfortunately, despite some respite from US inflation in July and August, there does not appear to be much reason to expect this selloff to stop anytime soon. With bearish momentum emerging for equities, and fears about an impending crash and recession growing, we have no choice but to get ready for the bear market.

What is a Bear Market?

Technically speaking, there is no strict definition for a bear market, since it is a more colloquial term than an exact set of financial conditions. However, it is generally agreed upon that when analysts refer to a bear market, they are discussing a financial market or index that has lost at least 20% of its value from recent highs. It is also worth noting that a bear market can occur without that market crashing, since a crash often refers to a dire situation in which said market loses at least 10% of its value in a single day.

Why is This Happening?

Many factors can contribute to a bear market, ranging from trade and foreign policy issues, to market-generated financial crises, to fiscal and monetary policy. In this particular situation, there appear to be two interrelated key catalysts creating a looming bear market in the United States:

1) An extremely hawkish Federal Reserve that is in eager pursuit of contractionary monetary policy, with economic growth being sacrificed accordingly. Chair Powell recently emphasized this at the FOMC press conference by explaining that for now, the Fed can only fulfill its ‘dual mandate’ by focusing on stabilizing prices at the expense of high employment, for the sake of eventual maximum employment. Stocks are not just a casualty in the effort to reduce high prices, they are a primary target.

2) Poor economic forecasts for both businesses and consumers, tied together in a vicious cycle. High interest rates will make it difficult for businesses to borrow or attract investors, as their high-risk shares and bonds will be far less lucrative compared to low-risk alternative securities. This nearly guarantees that they will have less capital to spend on employees, reducing employment opportunities and triggering layoffs for workers who are already struggling under the weight of high inflation and costly debts. These workers will then likewise spend even less, guaranteeing lower revenues for businesses accordingly, further impeding growth.

How Severe Will It Be?

For better or for worse, because of how unpredictable markets are by nature, we are effectively unable to know just how severe this bear market and recession could be. However, between the Federal Reserve’s far-from-spotless track record (2022’s hawkish Powell is, in fact, still the same person as 2021’s dovish optimist who dismissed inflation as ‘transient’), as well as the inherent lags in inflationary data such as Core CPI, the Federal Reserve could easily overshoot their tightening effort and create a depression.

This seems especially possible considering how badly the stock market has been hit while the labor market remains hot; these selloffs may become far worse as unemployment rates begin to increase, particularly if high global food and energy prices remain a problem for US consumers. However, because this hawkish monetary policy mission is consciously created by the Fed, rather than being the result of a structural failure as per the Financial Crisis of 2008, there is a chance that a meaningful economic recovery could be implemented more quickly than in decades past.

What Can Be Done?

Sadly, little can be done by working people to prevent a bear market from occurring beyond a miraculous, coordinated effort to voluntarily reduce consumer spending across the United States. Even if volatile food and energy prices continue to fall in a similar fashion as over the last few months, the Fed would still likely keep their eye on core inflation for a more complete picture. This downturn is being induced at an institutional level and is ostensibly unavoidable.

Nonetheless, for those who are long-term investors, bear markets also present myriad buying opportunities, as many shares across sectors are available at heavily discounted prices. For those who are patient and have some income to spare, building a diversified portfolio through recurring investments in safe, reputable funds remains a simple way to capitalize on poorly performing indices. While these methods by no means cancel out the horrors of economic suffering, value investing in this fashion offers consumers some semblance of wealth-building agency as we endure this business cycle.

Key Takeaways

• There have been significant declines in stock market prices since January of this year, with some indices, like the S&P 500, losing over 20% of their value. These trends sadly don’t appear to be stopping.
• A bear market is a term typically used in the context of a financial market or index that has lost at least 20% of its value from recent highs.
• While bear markets can occur for numerous reasons, the primary catalysts behind an impending bear market in the US appear to be hawkish aggression from the Federal Reserve and a bleak outlook for businesses, workers, and consumers accordingly.
• Although the exact dimensions of an anticipated bear market are unpredictable, it seems plausible that its severity could exceed that of current FOMC economic projections, though perhaps last more briefly because it is only artificially induced by the Fed.
• Unfortunately for working people, little will likely be done to prevent this downturn from happening at an institutional level. However, for those who can set aside some money for recurring and diversified long-term investments, buying opportunities will be plentiful.

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