Why the looming bear market will be different

By Julia Horowitz, CNN Business

When a bear market arrives, it’s not pretty, especially for investors making short-term decisions. But it happens — and a recovery arrives eventually.

Quick refresher: A “bear market” refers to when stocks drop 20% or more from their recent peak. They’re a sign of extreme negative sentiment on Wall Street and are more severe than garden-variety sell-offs.

Since World War II, the S&P 500 has experienced 17 bear markets or near bear markets, according to an analysis by LPL Financial’s Ryan Detrick. Number 18 is all but certain to arrive soon.

The S&P 500 is down 18.7% from its high in early January, battered by concerns about inflation, interest rate hikes and the war in Ukraine. Most traders don’t expect it to begin staging a sustained comeback for some time.

“The sour mood has been persistent,” Peter Boockvar, chief investment officer at Bleakley Advisory Group, wrote to clients earlier this week.

Historically, when the S&P 500 has entered a bear market, the average drop was almost 30% and went on for nearly a year.

That period is painful, but it doesn’t last forever. And importantly, bear markets haven’t always been precursors to recessions in the United States.

“In 1987, we had a bear market and no recession, and earnings continued to rise,” Edward Yardeni, president of Yardeni Research, told me. “That may very well turn out to be the environment we’re in now.”

Still, economists and investors acknowledge that the risk of a recession will rise as inflation eats into consumer spending and the Federal Reserve keeps hiking rates in a bid to combat the problem.

“The probabilities have been growing all year long,” said Darrell Cronk, president of the Wells Fargo Investment Institute. His team now believes it’s more likely than not that the United States economy shrinks later this year and in early 2023, he added.

What happens next? It’s easy for every bear market to seem like the end of the world, as nervous traders anxiously eye a sea of red. But to date, every huge bust has been followed by an even bigger rally. It’s just a question of when the recovery begins.

This time around, that timing is much harder to predict. Usually, a bear market bottoms out when the Fed decides its work is done and eases policy. But with inflation rising at the fastest clip in decades, the central bank has signaled that it intends to remain hawkish for some time.

“For the sake of its credibility, it has to stay the course here in terms of bringing inflation down,” Yardeni said.

In addition to raising rates, the Fed will soon begin the process of selling the bonds it bought in recent years, another mechanism for stimulating the economy. It’s never done that for very long before, which makes it harder to discern what the market response will be.

“The only time they’ve really done that with intent was the end of 2018 and they abruptly and quickly stopped that as growth rolled over in early 2019,” Cronk said.

That makes it difficult to find a helpful precedent for the bear market on tap.

“There’s not a lot of good models to use,” he continued.

China is flooding its struggling economy with support

China took major steps on Friday to rescue its slumping housing market and head off a major downturn in the world’s second largest economy.

The People’s Bank of China cut its five-year loan prime rate — a key interest rate — by 15 basis points to 4.45%, the second reduction this year and the largest on record. Most analysts had expected a cut of five basis points, my CNN Business colleague Laura He reports.

China’s so-called “LPR” is the rate at which commercial banks lend to their best customers. It serves as the benchmark for other loans and the five-year maturity is typically used as a reference for mortgages.

The central bank’s decision to slash the five-year rate is the latest in a series of steps that China has taken to tackle a real estate crisis as Covid lockdowns threaten to push the economy into its first quarterly contraction since early 2020.

Sales of new homes plunged 47% in April from a year earlier, the National Bureau of Statistics said earlier this week, while prices in 70 cities dropped for an eighth consecutive month.

Zhaopeng Xing, senior China strategist for ANZ Research, called the move a signal that leadership wants to backstop the struggling housing sector “as soon as possible.”

“It also suggests that China is making great efforts to achieve its 5.5% growth target” for 2022, he added.

Step back: The Chinese economy could shrink in the second quarter as Covid lockdowns weigh heavily on output. Consumer spending and factory production both shrank sharply last month, while unemployment surged to the highest level since the initial coronavirus outbreak in early 2020.

The property sector, which accounts for as much as 30% of China’s GDP, also faces a deepening crisis.

Evergrande — one of the country’s biggest developers — is undergoing a huge restructuring after it defaulted on its massive debts late last year. Analysts have long feared Evergrande’s collapse could ripple across the property industry.

People are just buying sweets and booze

In the United Kingdom, inflation is at its highest level since 1982 and growth is at a standstill — a toxic economic cocktail.

But there’s some good news: Brits are still shopping.

The bad news? They’re spending their money on alcohol, sweets and tobacco, a sign that people are spending more time at home as their expenses rise or seeking out small, inexpensive pleasures.

Breaking it down: UK retail sales unexpectedly rose in April, the government said in data released Friday. Inflation hit a 40-year high of 9% the same month.

But dig into the data, and it’s way less rosy. Yes, sales at food stores picked up — but that was driven by purchases of booze, cigarettes and treats. It’s hard to argue stress eating and other indulgences reveal that consumers are thriving.

“Don’t be fooled by the rebound in retail sales in April,” Niraj Shah of Bloomberg Economics said. “The biggest squeeze on incomes in a generation is set to further constrain consumer spending in the coming months.”

Investor insight: Concerns about the UK economy have caused the pound to collapse. The currency is down almost 8% against the US dollar year-to-date.

Up next

Deere and Foot Locker report results before US markets open.

Coming next week: Earnings season wraps up with results from Petco, Nordstrom, Dollar Tree, Nvidia, Alibaba, Macy’s and Costco.

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