Recession fears push stocks into bear market

THE world’s most important financial indicator has plunged into “bear market” territory as investors in US stocks fear a recession is on the way.

The S&P 500 fell another 1.8pc yesterday, taking its total losses since the peak at the start of the year to 20pc.

It means the S&P’S latest boom, which took hold after Covid sent shares tumbling in February and March 2020, is officially over. The fall has wiped out more than a year of growth in equities prices. At 3,831, the index of top shares is still trading at more than 70pc above its pandemic low of 2,237, however.

In recent years traders were fired up by ultra-low interest rates and rounds of quantitative easing from the Federal Reserve as well as heavy spending by the Trump and then Biden administrations.

However, that largesse has fed a consumption boom which is giving way to rampant inflation, requiring sharp rises in interest rates, which economists fear will result in a recession. Franziska Palmas at Capital Economics said that even shares in businesses selling consumer staples are suffering despite their usual resilience to economic slumps.

“Indeed, the recent sell-off in equities appears to have been triggered by some large US retailers warning supply disruptions and rising wages would weigh significantly on their margins,” she said.

Tech stocks have also struggled as the boom in valuations triggered by pandemic lockdowns has faded. Soaring oil and gas prices before and since the invasion of Ukraine have helped support the energy sector, however.

Inflation in the US hit a 40-year high of 8.5pc in March, slowing only a touch to 8.3pc in April. The Federal Reserve has so far raised interest rates from 0.25pc to 1pc. Britain’s FTSE 100 rose more modestly in the Covid recovery but has also been hit less hard by recession fears. It climbed 1.2pc yesterday.

It could be Monday. It might take until the end of next week. Or it might even wait until June. But it now looks inevitable that we will soon officially be in a bear market. The S&P 500, still the main global benchmark for investors, is already down 18.7pc this year. One more bad day and it will be officially in bear territory. The tech-heavy Nasdaq index is already there, and so are many other markets around the world.

Bear markets come and go. There have been 17 since the end of the Second World War, and they typically last close to a year, with share prices falling by 30pc.

But this could be a big one. Why? Because bear markets triggered by recessions are always the worst, and we are now heading for a deep downturn; because valuations were already crazily over-stretched at the peak; and because policymakers are completely out of ammunition to counter the sell-off in equities.

Then, add it all up and the market rout could well turn into one of the worst in post-war history.

The carnage in the stock market does not show any signs of letting up any time soon. The Nasdaq index is already deep into a bear market, down by 28pc since the start of the year.

The high-flying Faang stocks – standing for Facebook, Apple, Amazon, Netflix and Google – that led the market higher for so many years have crashed by 35pc since January.

The Meme stock index, which includes all the companies that generate the most social media activity, is down by an alarming 49pc over the course of 2022 so far (yet more proof that you shouldn’t use Twitter as a guide to anything, and certainly not for investing). The FTSE has held up reasonably well, down by a trivial 1pc so far this year.

But we should not kid ourselves that we are going to escape the sell-off. Our economy looks in as bad shape as any, and arguably worse. We have just been helped by the fact we never really joined the bull market.

Add it all up, and right across the world investors are getting out of the market as fast as they can.

It is not hard to work out why. After more than a decade of pumping money into the economy, central banks have finally turned off the printing presses, and started putting interest rates up again. Inflation has taken off and will depress demand as real wages fall. The war in Ukraine has sent commodity prices skywards, and will cause widespread shortages while lockdowns in China will cut off the supply of manufactured goods and key components. The outlook is as bleak as it has been at any point in the last 50 years and possibly worse. Against that backdrop, it is hardly any surprise that investors are getting out.

How bad will it get? The historical record suggests we have already taken most of the hit. According to LPL Financial, there have been 17 bear markets, or near-bears that include 19pc-plus falls, since the end of the Second World War. On average they lasted 11.4 months, with an overall fall in the index of 29.4pc. If that is a guide, we will see another 10pc fall, and it will all be over by the time Christmas comes around.

Here’s the problem, however. Averages are just that – an average. Some bear markets are relatively mild (the 19.3pc correction over six weeks in 1988 was the smallest of the post-war era) while others are a lot more severe (the 56pc drop over 18 months in 2007 and 2008 was the worst since the 1930s). In reality, this one is likely to be right at the top of the scale. Here’s why. First, the record shows that the sell-off is far worse when it is triggered by a recession. Of the 17 bear markets, nine have been accompanied by a recession (the markets predict at least two recessions for each one that actually arrives). On average, those last for 15 months, and witness a 34pc fall. With consumer confidence plummeting, retail sales starting to ebb, and inflation cutting hard into everyone’s living standards, a recession now looks certain. The only real question is how deep it will be, and how long it will last. That means stocks will fall harder, for longer.

Next, valuations were already extremely stretched. We all knew that a lot of companies were wildly overvalued by the end of last year.

‘We are not going to escape the sell-off. Our economy looks in as bad a shape as any, and arguably worse’

During the pandemic, tech companies had soared to crazy levels, but as Covid faded it turned out that we didn’t all want to sit at home watching Netflix and ordering noodles after all. We like to get out of the house occasionally. Cash shells that raised hundreds of millions to buy something or other have turned out to be worth much less than the money they raised. The result? Over-hyped, flimsy companies, with no real business model, have seen their values crash spectacularly as the froth gets blown away. It will take some big falls to get back to realistic valuations again.

Finally, policymakers are completely out of ammunition. The days of the “Fed Put” when, under Alan Greenspan, the Federal Reserve would respond to a market crash with cuts in interest rate and extra liquidity are now firmly behind us. Central banks cannot cut rates with inflation out of control. Nor can we expect governments to come to the rescue with higher spending and bigger deficits. They have already spent as much as they can. If anything, they will have to raise taxes to fix broken balance sheets, making the downturn even worse. This bear market won’t necessarily be up there with 2001 and 2008, when the index dropped by 49pc and 56pc respectively.

It might not necessarily match 1973 with its 48pc fall. But neither does it look like a mild correction before equities start to march higher again. There is still a lot of pain ahead – and this bear market will be a big one.