Bear Hunting

Hi everyone, Jay Pluimer here with Flourish Insights. As the director of investments at Flourish Wealth Management, I take pride in providing our clients, colleagues, and friends with resources and information that can help them make strategic and effective choices regarding their investments. Did you know we have an Alexa Skill? To listen on your Alexa device, just say, “Alexa, play Flourish Insights.”

Today, we’re going Bear Hunting.

We hit a milestone in mid-June when the stock market settled into Bear Market territory by dropping over 20% from its highs. The markets flirted with bear territory in late-May before recently exceeding that milestone. The NASDAQ 100 Index of Technology and Communications stocks has been in Bear Market territory for a few months, as just 8 stocks, all of which are in the NASDAQ Index, have generated about half of the losses in the S&P 500 Index for the year. In today’s episode of Flourish Insights, we will be discussing what brought us into Bear Territory, what it will take to recover, and what timelines might be involved.

Bear Markets are more typical than we might initially think. Each one is painful in its own way, but Bear Markets happen about every 6 years. Market dips often happen after periods of sustained gains, followed by a sharp decline like we experienced in 2018 (trade war with China) and 2020 (COVID crisis). The primary driver of the current bear market is Inflation. Although our economy continues to grow, inflation is slowing everything down and seems to be shifting into a more permanent – and scary – trend.

The sharper the market drop, in most cases, the quicker the recovery. The Federal Reserve has shifted into a more aggressive mode in an effort to decrease inflation, raising rates by 75 basis points during the most recent meeting with questions about whether or not they will raise by a similar level in late July. In the meantime, we are receiving negative economic data as manufacturing and service growth rates are coming in below expectations, new home sales rates have plunged due to higher mortgage rates, and consumer confidence has dropped to its lowest level in over 40 years.

It’s important to reiterate that a Bear Market and a Recession don’t always happen at the same time and can take place independent of one another. We don’t know if we are currently in a recession at the moment, as that determination is usually made a few months after the fact. However, stock market activity reflects expectations for the future so many analysts have been predicting that the Bear Market is predicting an upcoming Recession. The bad news is that the bear market isn’t over, and the market could continue to decline this summer. But the good news is that expected returns for the market to recover its losses are pretty attractive. The S&P 500 is currently down around 23%, meaning it would need to rise about 30% to breakeven. If it takes two years to make up that lost ground that would mean annualized returns of 14%, while a three-year recovery means 9% annual returns.

There are different types of Bear Markets, each of which reflect different conditions that led to the market dip along with a variety of factors that could contribute to the eventual recovery. The “easiest” form of a Bear Market is called Short and Shallow, similar to what we experienced in both 2018 and 2020 when it took less than 5 months for the market to dip, and then the market recovered to hit new highs within a year of the low. Another form of Bear Market is Long and Deep which is the variety that most people associate with bear markets because they include losses of more than 50% over the course of 12-plus months, plus much longer recovery times. If we can avoid an economic downturn, we are more likely to experience and short and shallow decline. However, a prolonged recession frequently means we will experience a long and deep market dip.

At this point we are leaning toward a short and shallow bear market with the possibility of a market reversal later in calendar year 2022. That is when the mid-term election cycle will wrap up and when we should start to see the economic effects of the Federal Reserve rate hikes. It is hard to know when high gas prices will ease up, but alleviating other inflationary pressures can go a long way toward creating a more favorable environment for stocks. For example, both stocks and bonds have performed well during periods when inflation is under 6%, so the Fed doesn’t necessarily need to eliminate inflation before we can see a market recovery. In general, only 15% of trading days in the history of the S&P 500 have taken place during a Bear Market while 29% happen during the recovery and the other 56% of trading days happen during Bull Markets.

At this point we plan to stay fully invested in the market, look for rebalancing opportunities relative to market opportunities, and make sure that client cash plans are in good shape. We have also been encouraging clients with cash on the sidelines to add money to their portfolios under the premise that the market is “on sale”. Although the market could drop further from where it is now, the opportunity to buy a long-term growth investment at a discount of over 20% is compelling for those that have the cash and the time for that type of investment.

For more up-to-date insights into the market, the economy, and what it all means for your portfolio, subscribe to Flourish Insights on Apple Podcasts, Spotify, or wherever you listen to podcasts. You can also find our full catalog of episodes at FlourishInsights.com. Thanks so much for listening, and don’t forget to stay focused and think long-term.