What is a bear market and why does it happen?
Bear markets are defined as sustained periods of downward trending stock prices, typically triggered by a 20% decline from recent highs. We saw this in June when the US S&P 500 officially entered a bear market for the first time since March 2020. Since then, we have seen a recovery of sorts but as of the year to date July 25 the S&P 500 was down 16.88%; the FTSE 250 of UK mid-cap companies was down 15.66% and the Europe's Stoxx 50 index was down around 16.43%.
Why are we in one?
Inflation is now at its highest level in 40 years, creating high uncertainty with regards to economic outlooks. This means the world’s central banks are tightening financial conditions and raising interest rates despite economic growth slowing down.
This is a difficult situation for investors. Because inflation is persisting the higher prices are damaging consumer confidence. As a result, we’ve seen companies adjust their outlooks and lose some value as markets now also price in in a potential recession.
Because investors are looking at future earnings, expectations of declining cash flows and profits are usually reflected in falling stock prices. In a bear market, investors become more risk-averse than risk-seeking, and the rush to protect themselves from losses can lead to prolonged declines in share prices.
Is a bear market a recession?
Bear markets often overlap an economic recession, but not always. A look at history reveals that of the 20 bear markets on the S&P 500 since the 1920s, 13 occurred alongside a recession.
What we do see when the two overlap is a bear market that tends to last longer and fall further. Data from the MSCI World Index (a broad global equity index based across 23 markets) suggests that the average bear market involves a drop of 25 per cent and lasts 170 days. When there is no recession, it's 150 days and it drops by around 21 per cent. But when it coincides with a recession, it lasts 260 days and the market falls around 40 per cent. The chart below, which shows drawdowns from the all-time high (zero), reveals that bear markets that occur outside a recession tend to be shallower and shorter.
China shows rays of hope
While there’s no doubting the difficulties investors are facing, it isn’t all doom and gloom.
A really good example of this comes from China. There’s growing evidence that, despite a strict zero Covid policy, the country’s economy could be turning a corner, having been quite slow in recent months.
One such sign is that we’re seeing an improving ‘Chinese Credit Impulse’ figure, which measures the change in public and private credit as a percentage of Chinese GDP. People and businesses are starting to borrow more, and that can give any economy a welcome boost. Historically, an improving credit impulse has been a good sign of better, future economic activity.
As the world’s second largest economy, China is very important to global growth, so a Chinese recovery could have a positive impact across markets. It’s already on a different trajectory to developed economies, its government focused on stimulating growth through direct financial support for its people and moves to stimulate broader economic expansion.
How we’re navigating current conditions for clients
At Coutts, we already knew that these challenging conditions were coming down the line and had positioned our client portfolios and funds accordingly. Here are just some highlights of how we’re navigating the current choppy waters:
- We had already reduced our exposure to inflation-sensitive growth stocks, such as technology, and mid-caps. Instead, we’ve focused on more resilient, large-cap stocks and defensive equities such as healthcare.
- With rate rises expected, fixed income has come under pressure, so we made sure we held fewer bonds than our benchmark. But more recently, the sector has started looking more attractive, so we bought more Investment Grade bonds where we’re seeing attractive yields.
- We see US inflation on a slightly different trajectory to UK inflation – potentially peaking sooner – and, with valuation levels not seen for years, we made a tactical decision to buy more US equities.
- With the outlook for the Chinese economy looking more positive, and the government focused on providing support, we increased our exposure to the country’s stocks via emerging markets and Chinese equity funds.
The value of investments can fall as well as rise and you may not get back what you put in. Past performance should not be seen as an indication of future performance.