Market Volatility
When will the bear market end?
Darrell Spence
Robert Lind
Jared Franz

As stocks and bonds continue to tumble after aggressive September interest-rate increases by central bankers in the U.S., Canada and England, investors are understandably asking how long this painful bear market will persist.

“It’s been a difficult year, and the pain may continue,” says Capital Group economist Darrell Spence. “But it’s important to keep in mind: One of the things that all past bear markets have had in common is that they eventually ended. Ultimately, the economy and the markets righted themselves.”

While past market results are not predictive of future results, it can be constructive to look at history. Based on the trajectory of past downturns, bear markets that were associated with a recession. tended to last, on average, about 18 months, Spence notes. So it wouldn’t be unusual for this one to continue well into 2023.

With recessions looming in the U.S., Canada and England — one may already be underway in Europe — it’s tough to see a catalyst for a near-term rebound, Spence says. Stocks and bonds are likely to come under further pressure as central banks continue to aggressively tighten monetary policy in an attempt to curb inflation, which is ranging from 7% to 10% in the U.S., Canada and England and above 10% in the European Union.

Stocks and bonds have tumbled this year as the U.S. Fed fights inflation

The image shows the downward trajectory of U.S. stocks, as represented by the S&P 500 Index, and bond returns, as represented by the Bloomberg U.S. Aggregate Bond Index, on a year-to-date basis, as of September 23, 2022. It also shows the timing and magnitude of interest rate increases by the U.S. Federal Reserve, including a 25-basis-point hike in March, 50 basis points in May, 75 basis points in June, 75 basis points in July and 75 basis points in September, bringing the current federal funds rate into a target range of 3.00% to 3.50%. Returns are in USD.

Sources: Capital Group, Bloomberg Index Services Ltd., Refinitiv Datastream, Standard & Poor’s. As of September 23, 2022. Returns are in USD.

Fed, Bank of Canada rate hikes shift into overdrive

Last week, the Fed raised its benchmark interest rate by 75 basis points for the third time since June. That hike brought the federal funds rate to a target range of 3.00% to 3.25%, the highest level since 2008. Based on the latest Fed projections, the central bank intends to take that rate above 4.50% in the months ahead.

Confirming the central bank’s hawkish stance, Fed Chair Jerome Powell said tighter financial conditions are necessary to achieve the goal of restoring price stability. That means bringing the inflation rate closer to the Fed’s 2% target.

“We have got to get inflation behind us,” Powell said during the Fed’s September 21 policy announcement. “I wish there were a painless way to do that. There isn't.”

It’s a similar story in Canada where the Bank of Canada (BoC) hiked rates by 75 basis points to 3.25% in September to fight inflation, which cooled slightly in July but is still running at levels not seen in decades. 

“Inflation is too high,” BoC governor Tiff Macklem said after the September rate increase. “It is important that we get inflation back down so Canadians can plan their spending and savings, and they don’t get surprised by big changes in their cost of living,” he said. 

The Bank of England (BoE) increased interest rates by 50 basis points in September to 2.25% pushing borrowing costs to the highest level since 2008. 

Financial assets have declined sharply since the central banks’ September moves, weighed down by the realization that they and other central banks around the world may have to raise interest rates more than previously expected. The S&P 500 Index, the Dow Jones Industrial Average and the tech-heavy Nasdaq Composite are all in bear market territory, defined as a decline of 20% or more from a recent high. The U.S. bond market, as represented by the Bloomberg U.S. Aggregate Bond Index, is down about 14% in U.S. dollar terms on a year-to-date basis, as of September 23.

Mounting troubles in Europe

Markets have also come under pressure due to events outside the U.S., including Russia’s escalation of the war in Ukraine, an economic downturn in Europe and a controversial U.K. plan that has triggered fears of a fiscal crisis. The £45 billion package of tax cuts had included a proposal to drop the tax rate from 45% to 40% for the country’s highest earners. Although the tax rate proposal has since been scrapped, the original proposal sparked a violent gilt selloff. That selling threatened to trigger a liquidity crisis in the U.K. pensions sector until the BoE stepped in with two weeks of emergency bond purchases.   

A European recession may already be underway due to the impact of higher energy prices, which have been exacerbated by the war, according to Capital Group European economist Robert Lind. A harsh winter could make matters worse, sending energy prices even higher.

“The depth and duration of the recession will depend largely on two factors: the war and the weather,” Lind says. “Both of which are impossible to predict.”

At the same time, Lind adds, the European Central Bank (ECB) and the BoE have no choice but to continue raising interest rates since they face the same elevated inflation levels as the United States. He expects the ECB and the BoE to raise rates through the fall and winter months.

The Fed pivot

Looking ahead to 2023, investors will turn their focus to another key question: When will central bankers stop raising rates or even start cutting again?

At the moment, there is little pressure for the Fed to change course, says Capital Group economist Jared Franz. Consumer spending is relatively healthy. The U.S. job market is extremely strong. And the unemployment rate remains near a record low of 3.7%.

But when the unemployment number starts moving higher — as it typically would during a recession — Fed officials will be forced to choose between fighting inflation and pushing millions of Americans out of work, Franz explains.

“It’s easy to talk tough on inflation when your unemployment rate is under 4%,” Franz says. “But what happens when it climbs to 6% or 7%? In my view, that’s about as much pain as the Fed is willing to accept. At the current pace of rate hikes, we’re on course to hit 7% unemployment in the second half of next year. I think it would be very tough to keep monetary policy tight in that environment.”

The BoC is walking the same tightrope as the Fed with the Canadian job market remaining strong. Although unemployment ticked higher to 5.4% in August from a record low of 4.9% seen in the previous two months, it remains near levels not seen since the early 1970s. 

Money markets are betting on a BoC hike October 26 with one more in December or January to bring the central bank’s policy rate to about 4%. 

Darrell R. Spence covers the United States as an economist and has 31 years of industry experience (as of 12/31/2023). He holds a bachelor’s degree in economics from Occidental College. He also holds the Chartered Financial Analyst® designation and is a member of the National Association for Business Economics.

Robert Lind is an economist with 35 years of industry experience (as of 12/31/2022). He holds a bachelor's degree in philosophy, politics and economics from Oxford University.

Jared Franz is an economist with 17 years of industry experience (as of 12/31/2022). He holds a PhD in economics from the University of Illinois at Chicago and a bachelor’s degree in mathematics from Northwestern University.

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