What You Need to Know
- Here are seven things to consider as the bear market deepens.
The U.S. stock market is very likely in a bear market that anticipates a recession will start later this year. This means the time is now to shift portfolios from risk-on mode to risk-off before the losses get even worse.
But what worked in the past when hedging against a bear market may not work now, given the ever-changing economic dynamics. It’s also important not to fall for some old myths.
In many ways, the economy is in uncharted waters. The pandemic spawned disruptions in global supply chains as frictions in the reopening of economies stoked inflation.
The war in Ukraine has sired additional price pressures that have left the Federal Reserve well behind the curve in fighting inflation and with its credibility severely strained. So the central bank is playing catch-up, and is considering multiple increases in its federal funds policy rate of 50 or even 75 basis points.
That and the recent bond markets yield-curve inversion, falling real wages as well as declining consumer confidence and real household spending, rising mortgage rates and excessive inventories almost guarantee a recession.
Then there’s the dramatic shift in Fed policy, from quantitative easing to quantitative tightening.
The central bank went from pumping $140 billion into the financial system every month, to winding down those purchases to nothing, to soon letting its balance sheet assets shrink — a big shock to equity holders who were accustomed to more-than-ample liquidity.
So as the bear market deepens, here are some thoughts:
Long the U.S. dollar against other major currencies.
As the recession spreads globally and equity markets swoon, the greenback’s haven status will become more even desirable. British sterling, the euro and the Japanese yen have been especially weak and will probably continue to be so.
The recent dramatic leap in yields may have fully discounted the Fed’s credit-tightening campaign. Also, as in the past, once the central bank realizes it has done the recessionary deed, it will reverse gears and ease credit. It’s normal for the Fed to cut the fed funds rate even before the onset of recession, and Treasury bonds rally at that point.
Stocks are a long way from the bottom if the recession and bear market unfold as I predict.
The S&P 500 is down 13.3% this year but has the potential to drop a further 32% given current valuations. Speculative stocks are especially vulnerable.
The long bull market since 2008 (with the exception of the early days if the pandemic in March 2020) and virtually free money has fueled highly leveraged positions that will only be revealed when those securities crumble. Robinhood Market Inc.’s collapse may be the harbinger of more to come.
Growth stocks can be disasters when their prospects fail to meet investor expectations, as was recently the case with Netflix Inc.
The stock fell 35% on April 11, dragging down other streaming stocks. Users flocked to Netflix in the early months of the pandemic while at home but easing lockdowns and competition from other streaming services in the past year have been brutal.
Netflix and other so-called FANG stocks depend on big earnings growth in future years, so they are extremely sensitive to interest rates that discount those earnings to determine present stock prices. Ten dollars in earnings 10 years hence is discounted to $9.05 today at 1% interest rates, but to $5.58 at 6%.