What A “Bear Market” Means


Thomas Lehr (Flossbach von Storch) | Equities are under pressure ‒ worldwide. The US market has also crossed a closely monitored mark. But there is also some good news.

The 2022 stock-market year got off to a promising start. On the very first day of trading, the S&P 500 equity index marked the highest closing price in its history at 4,796.56 points. For most investors, however, that is all there is positive to say about this year so far.

Since 3 January, with the exception of energy commodities, pretty much everything that could be put into a portfolio has fallen. Regardless of whether the portfolio had a large number of bonds, i.e. a rather defensive orientation, or a large number of equities and was therefore positioned more offensively. In the first half of the year, basically all investors will probably have to cope with more or less significant losses.

Because the decline of the S&P 500 at the 13 June closing price (3,749.63) added up to more than 20 per cent, the US equity market is now “officially” in a so-called “bear market”. Previously, i.e. up to this loss threshold, one could still speak of a “correction”. But does that change anything regarding investor sentiment? Or for the long-term capital market outlook? Let’s take it one step at a time …

All prices were rising ‒ until …

Interest rates are the gravitational force of the financial markets. The lower the yield on (risk-free) bonds, the more investors are tempted to look for alternatives. In addition, a low interest rate affects the valuation of investments. The lower the interest rate, the higher the value of future earnings, such as real estate or shareholdings in companies. It is therefore not surprising that with ever lower interest rates in recent years, the price of almost everything that is suitable as an investment has risen.

For some months now, this mechanism has been working in reverse. The culprit, as we know, is inflation, which the central banks thought for a long time was merely temporary. That is precisely why they reacted very hesitantly. Although inflation in the eurozone is now more than eight per cent, the European Central Bank (ECB) announced only last week that it would raise interest rates in July ‒ for the first time since 2011. Namely, by a quarter of a percentage point. For the deposit rate, it will go from -0.5 to -0.25 per cent.

If investors are now “worried” that the central banks could raise interest rates more quickly, then the question must be allowed whether this will really make the problem bigger or rather smaller. Yes, especially in the eurozone, there is concern that too strong a rise in interest rates could choke off the already fragile economy and lead to a recession.

But if demand is greater than supply and drives inflation, then falling demand could possibly be part of the solution. Even if more clearly rising interest rates would initially continue to weigh on bond markets and equities would remain under pressure. But that would be a snapshot. For those with a long-term investment strategy, the prospect of a successful fight against inflation would be good news!

All in all, the situation is far less complicated than headlines like “bond crash” or “equity bear market” might suggest. Both the bond and the equity markets have reacted much more vigorously than the central banks themselves ‒ and have thus already anticipated a great deal.

Better return prospects

For this reason alone, one should hope rather than fear that the central banks will finally follow suit. While the ECB has merely announced its first interest-rate increase, yields on 10-year German Bunds have risen more than two percentage points since August 2021. Italian government bonds are now yielding almost 3.5 percentage points higher than 10 months ago. These are just two examples. Of course, these yield increases mean sensitive price losses in a bond portfolio. However, it should not be forgotten that these losses are now offset by completely different yield prospects for the coming quarters and years. 

The same applies to investments on the equity market. Rising interest rates on the one hand and the successively gloomier sentiment over the past months on the other have made the valuation of shares much more attractive. This may be of little comfort to an investor looking at their portfolio today. But when it comes to investing money, the key is a long-term investment horizon. That is why patience is so important ‒ but not only that.

Because short-term fluctuations are the price of long-term, real capital preservation, investors need above all sufficient resilience against the emotional temptation to get out when there is a strong headwind. The bear market headline that has been doing the rounds as of today could fuel this temptation and is certainly having an effect on some investors. However, a look at the statistics may help here. The news of a bear market is not quite as bad as it sounds at first glance.

What the statistics “reveal”

Firstly, the moment you know with certainty that you are in a bear market, the worst is already over. This is already the 15th bear market since the Second World War. Such phases are therefore not uncommon and cost on average about 30 per cent. Currently, the S&P 500 is already 21.8 per cent below its high of 3 January. In addition, once the -20 per cent mark has been reached, things usually move quickly. On average, once a bear market is officially confirmed, it lasts “only” another three months.

Those who are not comforted by this may be optimistic about the outlook. One year after reaching the -20 per cent threshold, the S&P 500 was again up 18 per cent on average, and 23 per cent on median. That is at least a statistically significantly better outlook than at any other time since World War II. Since 1945, the average performance of the S&P 500 over 365 calendar days is only 9.9 per cent.

About the Author

The Corner
The Corner has a team of on-the-ground reporters in capital cities ranging from New York to Beijing. Their stories are edited by the teams at the Spanish magazine Consejeros (for members of companies’ boards of directors) and at the stock market news site Consenso Del Mercado (market consensus). They have worked in economics and communication for over 25 years.