Why an equity bear market is not our base case

By Lilian Chovin, Head of Asset Allocation, and Nathalie Malakee, Asset Allocation Analyst

• Investors may see some echoes of 2022 today, but the backdrop is very different. Economic growth remains resilient and recession risk appears low.
• Rising bond yields can create losses for bond investors, but they rarely create contagion and trigger equity bear markets on their own. History suggests weakening economic growth and corporate earnings are usually the bigger challenge.
• Our base case remains constructive. Equity markets may experience drawdowns, but we do not currently see the combination of conditions that typically causes a severe downturn.

Four years on from the 2022 equity bear market, comparisons with today’s investment conditions have started to surface. Major equity markets remain close to record highs, US equity valuations are elevated, bond yields are rising and inflation risks remain in focus. For many investors, this feels uncomfortably familiar.

But while the resemblance to 2022 is real, it does not necessarily mean the outcome will be the same. Elevated valuations and rising bond yields can make equity markets more vulnerable, but neither automatically leads to a severe drawdown.

The broader question is: what causes a drawdown to develop into an equity bear market? To answer that, we examined S&P 500 drawdowns since 1990 alongside the economic, valuation, and yield conditions surrounding them.

The value of investments, and the income from them, can fall as well as rise and you may not get back what you put in. Past performance should not be taken as a guide to future performance. You should continue to hold cash for your short-term needs. This article should not be taken as advice.

Drawdowns are common, bear markets are not

Market drawdowns are a normal feature of investing. Since 1990 (as at 5 October, 2026), monthly data shows the S&P 500 experienced 26 declines of at least 5%, but only nine of 15%, and six exceeding 20%.  

Most market setbacks therefore remain relatively contained. The dividing line for more severe drawdowns is often the underlying economy. Over the same period, there was a 75% probability of an equity market decline of at least 20% within 12 months either side of a US economic recession.

This makes intuitive sense. While softer economic growth alone does not necessarily present a significant problem for equity markets, broader economic weakness that threatens corporate earnings can have a much greater impact.

The challenge for investors is that economic downturns are only identified with certainty in hindsight, often after equity markets have adjusted. This is why our proprietary US recession indicator tracks housing, consumption, confidence, labour markets, and business surveys to assess whether weakness is becoming broad-based.

Historically, when our indicator pointed to such economic weakness and elevated recession risk, the probability of an equity market decline of at least 15% over the following 12 months rose from 20% to 60%. For declines of at least 20%, it increased from 13% to 52%. 

Drawdowns are distinct episodes; probabilities measure declines over the following 12 months. High valuations are defined as periods where P/E valuations are in the top quartile. Periods of heightened economic weakness are defined as those when our proprietary US recession indicator exceeds 35% and our economic growth indicator signals contraction.

Valuations are also a potential source of vulnerability, but they appear to be less important than economic weakness in determining whether a drawdown becomes more severe. 

Our analysis shows that, when valuations were in the highest price-to-earnings quartile, the probability of a decline of at least 15% over the following 12 months rose from 20% to 37%. The likelihood of a fall of 20% or more rose from 13% to 28%. So high valuations alone do not inevitably lead to severe declines. 

What about rising bond yields?

Rising bond yields are another source of concern today and were an important feature of 2022. High yields can put pressure on equity valuations, but history suggests they are not, on their own, enough to cause an equity bear market.

Across seven periods of rising yields since 1990, an equity market decline of at least 20% occurred only once, in 2022. Even some of the largest increases in yields coincided with positive equity returns.

What made 2022 different was what accompanied the rise in yields. Core US PCE inflation accelerated from 1.5% to 5.2% during 2021, ultimately prompting 525 basis points of policy tightening. Higher rates weighed on equity valuations just as our economic growth indicator moved from slowdown to contraction. Exceptional monetary tightening therefore amplified an already weakening fundamental backdrop.

The period was particularly difficult for multi-asset investors because bonds offered little protection. Yields started low, leaving investors with limited income to offset their sharp rise and the resulting fall in bond prices. Equities and bonds therefore declined together, removing an important source of portfolio diversification.

Why today is different

We have a very different starting point today. Core PCE inflation is currently 3.0% and has been relatively stable over the past year, rather than accelerating sharply as it did ahead of 2022. Our analysis also points to moderating rather than contracting growth, with recession risk low. Meanwhile, real yields are substantially higher than they were entering 2022, making another tightening cycle on the same scale less likely.

The maths for bonds has also changed. If a bond portfolio yields around 5% and has a duration of roughly seven years, yields would need to rise by approximately 70 basis points over 12 months to create capital losses that outweigh starting income. Bond losses on the scale experienced in 2022 would therefore require a much more extreme rise in yields.

This does not mean yields cannot rise further. But recreating the combination that made 2022 so difficult would require much more than higher yields alone. It would require a renewed inflation shock and substantial monetary tightening alongside a material deterioration in growth and earnings. Today, we do not see those conditions.

What would change our view?

We would become more concerned if:

• our recession indicator rose materially as weakness spread across labour markets, consumption, and business surveys
• earnings expectations shifted from slower growth to outright declines
• financial conditions tightened sharply.

We are also monitoring the concentration of earnings growth. A large share of equity market strength is linked to artificial intelligence-related investment, and a material slowdown there could weaken aggregate corporate earnings even without broad economic deterioration.

But we currently do not see signs of these developments, and a severe equity drawdown is not our base case.