Is It Bear Season? Inflation, Interest Rates, And The Stock Market

key takeaways

  • Bear markets are defined by a 20% drop in stock prices.
  • The average duration of a bear market is usually nine months.
  • Investors can use dollar cost averaging during bear markets to increase their overall returns.

Is it bear season? The stock market has been on a rollercoaster ride lately, and many investors have differing opinions on where the market is headed next. Some predict the next accident. Others expect inflation to cool and the stock market to rise.

You’re not alone if you’re nervous about investing in the current market, due to a potential bear market, or simply the current level of volatility. But is now really the time to sell your position? Or is it just a normal part of the investment cycle? Let’s explore what’s happening in the market and help you decide if now is the right time to invest.

What defines a bear market?

The first thing we need to do is understand what a bear market is. A bear market is when stock prices fall 20% or more from their peak. Usually, this downtrend lasts around nine months, but this is not always the case. For example, the stock market entered bearish territory in February 2020, but it only lasted a month.

Before that, the last prolonged bear market was during the Great Recession of 2008. That bear trend lasted 17 months. The bear market in 2000 lasted 31 months. Finally, when we talk about a bear market, we are talking about the entire market in a downtrend.

What causes bear markets?

There are a variety of things that can cause bear markets, but they usually happen when there is an economic downturn. Other causes include rising interest rates, oil price shocks, economic changes, and political turmoil.

In the case of the current level of market volatility, there are multiple causes. The global pandemic forced the government to spend money, which increased the rate of inflation and disrupted the supply chain. Demand exceeded supply, so prices rose. The Federal Reserve was slow to react, thinking higher inflation was temporary. We now have a very high rate of inflation and an aggressive Federal Reserve raising interest rates to control inflation.

High inflation and rising interest rates have forced many investors to take a defensive stance, leading to our current bear market.

Watch out for a bear market rally

It is important to know about a bear market rally, as this common occurrence can hurt investors. A bear market rally is when stock prices bounce off their lows for some time before returning to a downtrend.

There is no formal definition of a bear market rally. However, many experts agree that this is when stock prices rise 5-10% from their lows. This rally can last for a few weeks, up to a few months.

Why do these rallies happen? During a price drop, many investors panic and sell, sending prices lower than they should be. Long-term investors see these bargain prices and buy shares, driving prices up. Once this demand dries up, stock prices resume their downward trend.

Every bear market from 1901 to 2015 has had at least a 5% rally each time. About 66% of the time, there has been a 10% spike. Investors should be aware of this fact and plan accordingly.

Inflation is high, will it go higher before going down?

No one knows where inflation goes from here. If you talk to ten economists, you can get ten different answers. Some believe that inflation has peaked and should be falling from here. Others believe that it is still rising and that the latest inflation report showing cooling is misleading. Still, others think that where inflation is today it will remain for years.

As an investor, your best bet is to prepare for the worst while remaining flexible to take advantage of changing market and economic conditions.

This could mean taking a more defensive stance with your portfolio. Or it could mean building up a cushion of cash, so you have funds to slowly invest in the market as it falls, buying stocks at a discount.

Interest rates are up. Will they stay awake?

The Federal Reserve is aggressively raising interest rates and there is no sign that they are going to ease until inflation returns to 2-3% per year. Because of this, investors should plan for higher interest for the foreseeable future.

While higher interest rates alone do not imply a bear market, an inverted yield curve more accurately predicts a falling stock market. This is when longer-dated bond yields are lower than shorter-dated bonds of the same credit quality. Investors assume that they will get a higher return on longer-dated bonds, as it involves more risk. When yields change or reverse, investors are pessimistic about the short-term outlook for the economy.

Seeing how the inverted yield curve has recently deepened, it is fair to assume that an economic downturn is looming in the future, if not already here.

Current market observations

Current market conditions point to the stock market being in a bear market with no end in sight. After falling to the low of the year in June, the market rallied more than 15% in mid-August, a classic sign of a bear market rally. But then Federal Reserve Chairman Jerome Powell reiterated the Fed’s aggressive stance to keep raising interest rates. Since then, the market is down more than 5%.

There are other signs that the bear market will continue, namely higher interest rates. With higher rates, companies will borrow less to finance their growth. As a result, earnings estimates will decline and investors will look for other safer alternatives to invest.

The only good sign is the strength of the US dollar. A strong dollar helps keep commodity prices, specifically oil prices, in check and manipulate demand. With less demand, oil prices may start to decline.

A long-term perspective. Should I be reassigning?

An important question investors have about the current state of the economy is whether they should reallocate their portfolios. The answer to this question is complex and depends on your investment objectives, time horizon and risk tolerance.

You may not need to do anything if you have a long-term time horizon. History has shown that bear markets don’t last forever, and the market always recovers. At a minimum, you should put the cash you have on the sidelines to work for you by investing strategically as the market moves.

If you’re closer to retirement or need to access your money in the next five years, you may want to take a more defensive stance. This could include selling some of your stock and investing in bonds or cash. As interest rates rise, certificates of deposit are worth looking at as they could build a ladder of CDs that would provide security against loss and offer income.

It’s smart to look at Q.ai’s investment kits. These are pre-built investment strategies that offer a variety of themes (inflation, emerging technology, vault of value, crypto, etc.) for every type of investor, whether you’re nearing retirement or just starting out as an investor.

It is also important to remember that no one knows when the bear market will end. By taking a more defensive stance, he is saying that he is not confident that the market will recover anytime soon. By doing so, he could miss out on significant gains if the rally starts sooner than expected. That’s why you should take the time to create a detailed investment plan that assesses your risk tolerance. This will allow you to ride out any volatility in the market and ensure that you are prepared to take advantage when the market eventually recovers.

Is this a stock buying opportunity?

Any time the stock market falls by a significant amount, say 20% or more, it usually indicates a buying opportunity. The issue is that no one knows where or when the bottom will occur. In other words, just because the market is down 20% doesn’t mean it’s going to bounce back from here. It could trade sideways for a while or trend even lower.

Since nobody knows, a smart approach is to calculate the dollar cost average of your investments. This allows you to invest a small portion of your investable cash every few months. For example, if you have $10,000, you could invest $2,000 each month for five months. Doing this increases your chances of buying on the lows, so you can make a more significant return as the market moves higher.

Bottom line

The stock market is in a bear market, and all economic signs point to a prolonged stay here. As an investor, the last thing you want to do is make an emotional decision with your money. Instead, take the time to understand what a bear market looks like and how it normally acts. From there, you can build your portfolio or reallocate it so you can keep investing without losing sleep at night.

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