The phrase ‘bear market’ has been thrown around a lot lately, but it actually has a very specific meaning. In financial speak, markets or assets are said to be in a bear market when their values decline 20% or more from a recent peak. Using that definition, the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite Index all entered bear markets in March.
Markets experienced a brief resurgence at the end of the month after the Trump administration pushed a $2.2 trillion stimulus package through the Senate. But fears of a bear-market reversal remain in focus as the economy heads toward recession.
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Key Bear Market Indicators
While no two bear markets are exactly alike, there are a few tell-tale signs that could indicate the start of a major downtrend. Let’s go over some of these.
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1. Falling Corporate Earnings
A decline in corporate earnings is one of the most obvious signs that a downtrend is likely. If you believe that asset values should reflect underlying fundamentals (i.e., profitability, revenues), then a decline in these key metrics should impact the price of stocks.
Companies in the S&P 500 have been battling a so-called earnings recession for well over a year now. The recession only ended in Q4 2019 when S&P 500 companies reported a tiny year-over-year blended earnings growth rate.
2. Underperformance of Low P/E Stocks
When stocks with low price-to-earnings ratios underperform the broader market, it means that investors are overly fixated on high-growth names. What ends up happening is the most expensive names drive most of the returns in the market. Undervalued companies – like those with low PE ratios – end up being forgotten. That’s exactly what we’re seeing in today’s market.
3. Lackluster Economic Growth
With coronavirus ravaging the U.S. economy, Goldman Sachs recently issued a forecast sighting contraction of up to 24% in the second quarter. That exceeds anything we’ve ever seen in the post-war era.
While Goldman expects a swift rebound in the second half of the year, the U.S. and global economies have been mired in a ‘growth recession’ for years. Slower growth was widely forecast even before the coronavirus crisis unfolded, with the likes of the International Monetary Fund, World Bank, and Organization for Economic Cooperation and Development downgrading their global outlooks.
4. Inverted Yield Curve
Wall Street’s favorite recession indicator – the inverted yield curve – also has important implications for stocks. Since recessions often lead to bear markets, it stands to reason that economic downturns are bad for risk assets like stocks.
The inverted yield curve – when short-term bonds yield more than longer-term equivalents – first popped up in summer 2019. If history is any indication, then a recession could follow two years later.
5. Tightening Credit Conditions
When it becomes more difficult for companies to borrow money from the bank, it usually means that financial institutions are tightening their belts over concerns of an economic slowdown. A recent survey by the Federal Reserve found that banks expect credit standards to tighten moving forward. That might have changed following the Fed’s emergency interest rate cuts, which brought the target for the federal funds rate back down to 0% to 0.25%.
Other bear-market indicators include weaker business investment, a slowdown in manufacturing activity, and declining consumer confidence. All of these conditions characterize the current economic scenario.
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The Bottom Line
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