US S&P 500 ‘bear market’: How did it happen, what will it mean?

Stocks have ticked steadily downward as the US Federal Reserve bank raises interest rates.

the New York Stock Exchange building
The New York Stock Exchange - the S&P 500 has entered bear market territory [File: Mike Segar/Reuters]

As investors grow increasingly worried about inflation and higher interest rates, Wall Street has fallen into a bear market.

The US Federal Reserve bank has indicated that it will push up interest rates as it struggles to curb the highest rates of inflation the country has seen in decades. The uncertainty unleashed by Russia’s invasion of Ukraine and the slowdown of the Chinese economy has also resulted in declining stock prices in sectors from tech to car manufacturers. Increasingly volatile changes in the value of stocks have become more common.

The US last entered into bear market territory about two years ago. Aggressive action by the Federal Reserve throughout the pandemic kept stocks moving in an upward direction, but substantial losses in high-risk assets such as cryptocurrencies have damaged investor confidence. Near the end of 2021, Bitcoin was valued at nearly $68,000. As of Monday, that value had dropped to less than $23,000.

Here is more information about “bear markets”.

Why the term ‘bear market’?

A bear market is used to describe when a stock index such as the S&P 500 or the Dow Jones Industrial Average drop by 20 percent over a sustained period after a recent high.

Sam Stovall, a chief investment strategist at CFRA, told the Associated Press that the term “bear market” is used because bears hibernate, representing a market that has slowed down or ceased moving forward. The term “bull market” is used to describe the opposite: a market charging forward.

In the US, the S&P 500 is seen as a vital indicator of Wall Street’s confidence, or lack thereof, in the market. That index fell nearly 4 percent on Monday, and is more than 20 percent below a record high that it reached earlier this year.

The Dow Jones sank by almost 3 percent on Monday, and the Nasdaq, which is composed largely of tech-related stocks, fell by nearly 5 percent.

The most recent bear market for the S&P 500 was also the shortest: between February 19, 2020, and March 23, 2020, the index dropped by nearly 35 percent.

Why are investors worried?

The primary cause of concern among investors is interest rates, which are ticking steadily upwards to combat high levels of inflation that are hammering the economy. If low rates tend to cause stocks to rise, higher rates can have the opposite effect.

The Federal Reserve, which was focused on propping up markets during the pandemic, has now zeroed in on combatting rising inflation. Record-low interest rates had made it easier for investors to shift money into less stable assets such as stocks and cryptocurrency, hoping for higher returns due to the riskier nature of the investment.

Those near-zero interest rates are now coming to an end. Last month, the Fed indicated that new rate increases are likely to occur in the next several months, and could be as much as double the normal increases. Consumer prices have risen nearly 9 percent from May of 2021 and are now about the highest levels in 40 years.

By making the cost of borrowing money more expensive, the rising rates will slow the economy. This can help curb inflation, but also comes with the risk of triggering a recession if rates go up too much or too quickly.

Rising commodities prices have also been pushed upward by Russia’s invasion of Ukraine, contributing to rising inflation. Concerns about China’s economy, the second-largest in the world, have also been the source of a worsening outlook from investors.

Avoiding a recession?

While the Fed will attempt to balance containing inflation with the need to avoid sparking an economic downturn, rising rates will likely push stocks down.

If it costs more to borrow money, consumers cannot buy as much stuff, and a company’s revenue can decrease. If stocks tend to keep up with profits, higher rates also make the elevated price of stocks less attractive. Less risky assets, such as bonds, also pay more due to the rising interest rate of the Fed.

Stock for big tech companies and other sectors that have done well during the pandemic entered the year priced high, and are now likely to see some of the steepest drops as interest rates rise. But retailers, sensing a shift in consumer behaviour, could also suffer.

The bond market is also seeing signs of a possible recession. The yield on two-year Treasury bonds temporarily surpassed the yield of 10-year Treasury bonds. That reversal, with higher yields for more short-term bonds, has typically been seen as an indicator of a recession, although the timeline for such a downturn is less certain.

According to the AP, Ryan Detrick, chief market strategist at LPL Financial, has said that when a bear market and a recession come together, the stock decline average is usually about 35 percent. When the economy manages to avoid recession, that number drops to about 24 percent.

Should I sell now?

While many advisers have said that riding the lows and highs are part and parcel of investment, stocks tend to provide strong returns over the long term. However, for those in need of money now, or looking to lock in their losses, the answer is yes.

Discarding stocks could help prevent further losses, but comes with the risk of forfeiting potential future gains. Often, bear markets, or the days following them, see some of the best days for Wall Street. In the middle of the 2007-2009 bear market, for example, there were two separate days when the S&P 500 jumped forward by about 11 percent. During and after the 2020 bear market, which lasted approximately one month, there were also leaps of more than 9 percent.

However, advisers suggest further stock investments only if that money will not be needed for several years, giving the market time to rise out of the bear markets and regain its value, then going on to new record highs.

Even during the 10-year period following the eruption of the dot-com bubble, a particularly difficult period, stocks have often gone on to reach high points within a couple of years.

How long will the bear market last? How bad will it get?

Since World War II, bear markets have typically taken 13 months to go from high to low, and 27 months to regain their previous value. The S&P 500 index has decreased by an average of 33 percent during bear markets in the same period. The steepest downswing since World War II occurred in the bear market that lasted from 2007 to 2009, when the S&P 500 decreased by 57 percent.

Historically, bear markets that occur rapidly tend to be shallower, and stocks have usually taken a little more than eight months to fall into a bear market. During times when the S&P has dropped by 20 percent more rapidly, the average loss for the index has been 28 percent.

The longest bear market ended in March 1942 after just more than five years, dropping the index by 60 percent.

When can I be sure the bear market has ended?

Investors look for consistent gains during a six-month period, and an increase of 20 percent from a low point. Following a low in March 2020, for example, it took stocks less than three weeks for stocks to go up by 20 percent.

Source: Al Jazeera and news agencies