What the Bear Market Means
On June 13, 2022, the S&P 500 Index – a broad measure of U.S. equities – fell into bear market territory for the first time since March 2020. So-called “bear markets” are defined by a decline of 20% or more from recent highs. Through the market’s close on June 14, 2022, the major benchmark had sunk 21.1% year-to-date.
What causes a bear market?
The “bear” represents a market in retreat, as a bear hibernates for winter. Bear markets are historically the result of recession concerns and take hold for varying lengths of time. The March 2020 bear market brought on by the COVID pandemic lasted just one month and was the shortest bear market in history. The longest and most severe bear market in U.S. history lasted from 1929 to 1932 and was accompanied by the Great Depression.
Several factors are colliding to cause our newest bear market, but put simply: Inflation is running hot, interest rates are rising to cool it, and stock valuations have fallen in response. Compiling the predicament is how poorly bonds are performing. The classic portfolio of 60% stocks/40% high grade bonds has not performed worse since the Great Recession of 2008. While bonds typically provide ballast during stock market sell-offs, that has not been the case this year. This bear market has been driven by the bond market.
What does the bear mean for investments?
Cash and cash equivalents aside, there have been few places to invest and avoid the drawdown. The latest headline Consumer Price Index (CPI) inflation reading was 8.6%, while core CPI measured 6.0%. Core CPI excludes volatile components such as food and energy.
The U.S. Treasury yield curve has risen dramatically while long-rates have flattened. Curve-movements of this type are known as “bear flatteners,” and as sure as bond prices fall when interest rates rise, fixed income offered investors no safe-haven. The 10-Year Treasury yields have more than doubled since the start of this year, climbing from 1.52% to 3.43%. To highlight how flat the long-end of the curve is, 30-year Treasury yields offer 3.42%.
Stocks have “re-rated” from valuations not seen since the dot-com bubble. Stock prices had roared to a forward price-to-earnings valuation over 23x in response to the pandemic fiscal stimulus and monetary policy support and valuations remain above long-run levels. The forward-looking P/E multiple of the S&P 500 is 17.3x. Over the last 40 years, this measure averages 15.5x. If history is a guide, either continued strong earnings growth or further price declines are needed to support still rich valuations.
What is working?
Energy (+50.6% YTD) and high-quality blue-chip dividend stocks have held in. Further, some flight to safety has caused Utilities (-8.0%) and Consumer Staples (-10.7%) to hold up better than the broad market. Alerus Income Builder portfolios have benefited from this sector favoritism. But broadly, equities will again become an appealing overweight if inflation can be contained without causing a recession.
Our investment philosophy continues to take a long-term view and manage risk through asset allocation. A bear market represents short-term challenges and may cause concern for immediate needs but does not present unprecedented conditions. Our experienced team is monitoring the changes closely and will continue to focus on long-term results.