4 Risks of a Bear Market for Stocks Today

The S&P 500 and Nasdaq 100 indexes are coming off their best weeks since November 2020 even after a rough start to the year. But the question now for investors is whether the gains will stick.

It’s a unique moment for the U.S. stock market, which is staring down a distinct set of circumstances — from geopolitical risks to rising interest rates — that when combined have historically led to a bear markets.

First, the Federal Reserve is starting to raise interest rates, with the first quarter-point hike coming last Wednesday and many more on the way.

Then there’s Russia’s war with Ukraine, which is creating a humanitarian crisis in Europe and destabilizing financial markets around the world.

Meanwhile, oil prices are soaring past $100 a barrel and threatening to further stoke inflation, which is already at a 40-year high. And parts of the Treasury yield curves are inverting.

Here’s a look at what history says about the U.S. stock market when these factors collide.

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The History of Bear Markets

The S&P 500 bull market will turn two on Wednesday after the index staged a stunning rebound from the Covid-induced economic downturn after it bottomed on March 23, 2020, wiping out about 34% of its value. Since then, the index has doubled in the face of the worst global pandemic in a century.

However, since World War II the combination of a Fed rate-tightening cycle, geopolitical tension, high inflation and a flattening yield curve have triggered a bear market, or a 20% decline from the index’s peak, according to investment-research firm CFRA.

Unique Cross-Currents

It’s rare for the Fed to raise rates at a time when markets are under pressure and geopolitical tensions are bubbling.

In fact, the last two times the S&P 500 entered a correction or bear market while the Fed was in a tightening cycle occurred during the Hungarian uprising and Suez Canal crisis of 1956 and the Tet Offensive in 1968, a pivotal moment in the Vietnam War in which the North launched a coordinated attack on the South and inflicted severe casualties.

Sector Clues

How particular industries perform in the near term could provide investors with more clues on the trajectory of the market. Late-cycle cyclical sectors like materials and industrials, along with defensive-natured groups like consumer staples and health care tend to be strong six months ahead of a recession.

But rate-sensitive stocks like financials and real estate, as well as growth-oriented companies in technology, consumer discretionary and communication-services sectors, historically lag. For the S&P 500 to sink into a bear market, cyclical value and defensive sectors will likely need to drop much further from current levels, according to Ned David Research.

Moderating Returns

To be sure, most economists don’t anticipate that the U.S. economy will fall into recession in 2022, due to a strong labor market, robust consumer spending and better-than-expected corporate profits.

Another part of the yield curve inverted Friday, with yields on three-year Treasuries rising above five-year Treasuries for the first time since March 2020. The spread between two-year and 10-year yields, which has historically been a gauge for recession, has also narrowed. But the 10-year yield compared to three-month Treasury bills, which has similarly predicted downturns, is actually steepening.

Still, analysts do expect the market to deliver more moderate returns from here as the Fed withdraws monetary policy support from the financial system. However, stocks may still have room to run. Since 1957, the average bull market in the S&P 500 has lasted 5.8 years, according to Truist Advisory services. The current bull market is just two years old.

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4 Risks of a Bear Market for Stocks Today

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