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Has the market bottomed? If not, when will the bear market end?

Why have things turned so bearish this year? Is the recent bounceback a signal of the bottom, or when will it end? What is the meaning of life?

Three big questions.  While I’m not so sure I’ll get to the last one today, let’s at least address the first two.

Why are we in a bear market?

Let’s take the low-hanging fruit first. Why is an easy one to answer. Markets are cyclical, and what we are seeing right now is no different than previous decades. The boom-bust nature of the economy is known to all, and following the misery of the 2008 crash, it’s been smooth sailing in the markets with a up-only bull run that has lasted over a decade.

I plotted the stock market return against recessions over the past 100 years, with the below putting into context how long the recent bull market ruled for when compared to previous cycles.

So ya… it’s not exactly a surprise that Daddy Recession came knocking on our doors. Like your school principle after you’ve been kicked out of Irish class for throwing a classmates sports gear on top of a projector hanging from the roof, he was always going to arrive at some point (just a weirdly specific hypothetical).

But why now?

Money printing and inflation

Some people have a habit of eating, sleeping, socialising or staying alive. If you fall into one of those categories, you likely have noticed that things are more expensive, as inflation is gripping the economy.

This is due to a number of factors. The Russian war doesn’t help – energy prices have gone bananas and the oil situation is obviously heavily impacted. However, inflation was spiralling well before Putin invaded Ukraine in February.

There were also supply chain issues, suppressing supply with the only natural “solution” for prices to rise as demand gets pent up.

However, it’s Uncle Jerome who is the biggest factor here. That is, Jerome Powell and the Federal Reserve, who printed more US dollars than at any point in history. Known as quantitative easing, this is a programme which pumps money into the economy in order to simulate demand and growth.

Of course, printing more money means the value of existing money goes down. Which is exactly what happened. And if money is worth less, goods are worth more. Bingo. Sometimes things don’t need to be overcomplicated.

All good things come to an end

While this money printing was all well and good to get the economy back on its feet post-pandemic, the scale of the dollars printed is so large that inflation has spiralled out of control.

The Fed’s response here is what has since caused markets to tumble. In order to rein in inflation, liquidity needs to be pulled out of the economy, rather than injected like it had been previously. That means quantitative easing is over, and instead we are struck with interest rate hikes. This serves to rise the cost of borrowing, which slows down economic growth. The cost to service credit card debt, auto loans, personal loans and so on also increase.

The Fed has hiked four times in 2022 thus far, with rates sitting at 2.25%/2.5% currently. Right now,  it seems likely September will see another hike, despite the slightly lower inflation reading that was announced this week.

When will the bear market end?

This is the trillion dollar question really.

Let’s look at this historically first. The average drawdown across the bear markets since World War II (let’s toss out the Great Depression and everything else pre-war) is -33%. The peak-to-trough drawdown this year, at its nadir, was a shade over -24%.

But this climate is somewhat unique, in that the scale of the money printing is so large. Ultimately, the timing for when we bounce back (assuming the bounce back has already not occurred) will be driven by the Fed’s action.

Some analysts believe that inflation has peaked, however the bulk do expect further pain. This could mean further rate hikes, and a further supressing of the economy. Once these hikes ripple through the economy, earnings forecasts will drop and recession will hit (or hit harder, if you want to say we are there already). The key questions is then:

“Do the Fed pivot and fire back up the money printer?”

Likely, politics will come into this. Don’t overlook the midterm elections edging closer, nor the historically low approval rating of Joe Biden. Also relevant is the fact that Powell and the Fed still, despite maintaining they intend to reduce inflation at all costs, do not want to cause a nasty recession.

Will the Fed fire back up the money printer?

Housing data, unemployment data, inflation data (again) could all throw in the spanners in the works here. Yet another volatile situation is the Russian war – Putin could do something to throw the whole thing into disarray. Oil is intrinsically linked to the happenings in Ukraine, and I wrote a couple months ago about how pivotal oil can be with regard to timing market bottoms.

The answer you don’t want to hear, albeit the right one, is that nobody knows whether we have bottomed. There are simply too many macro variables in the mix here. I have a gut feeling that we have more blood to give, but I also had a gut feeling that Leicester would get relegated in 2016, and 9 months later they won the Premier League.

It’s still a good time to buy

What I will say is that the one thing that we know for sure is that after drawdowns of this magnitude, historically it’s a good time to buy. You need only scroll up to the S&P chart plotted above to see this. Sure – the drawdown could get really nasty, and perhaps even we give 33% more.

But the flip side is that, with a time horizon long enough, it’s near guaranteed to rise up above it within the next few years – particularly when considering the Fed are unlikely to sit on the sidelines if things do get really bad. Personally, being in my mid-twenties with no large purchases planned in the next few years, I’m comfortable with the risk/reward here, and with history on my side and my timeframe clear, it’s right for me.

I think that looking at this from an expected value point of view is useful. With a time horizon long enough – and that is the key – it’s a nice time to buy. But everybody is different, with different financial goals, risk tolerances and time horizons. If your time horizon is not long-term, it’s a whole different ball game. Or to summarise the above article in three words: I don’t know.

The post Has the market bottomed? If not, when will the bear market end? appeared first on Invezz.

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