After a turbulent first half of 2022, the question for most investors is whether we are experiencing a bear market or if we are entering a new bull market.
Our quantitative models that analyse macroeconomic and financial market data to evaluate the market have observed a striking number of similarities to market phases in 1990 and 2007; both of which were turbulent times for financial markets.
Looking at current data from a top-down perspective indicates an increased probability of remaining in the bear market: both the massive fiscal packages introduced in 2020/21 due to the pandemic and quantitative easing are currently being scaled back. This is reflected in a sharp decline in global liquidity.
However, remaining in a bear market by no means rules out further rallies. In the past 20 years there have been a total of five bear markets from the dot.com crash, global financial crisis, European sovereign debt crisis, pandemic and most recently Russia’s invasion of Ukraine.
However, except for 2020, these all included at least two rallies. In one of these (in 2000-02), the S&P 500 climbed by as much as 21% before prices dropped again.
There are good arguments to assume at least one short-term rally within a bear market, which is especially true if the Fed’s monetary policy tightening and US inflation have already peaked.
This is supported by improvements in global supply chain issues and the fact that commodity prices declined again over the summer. Weaker global consumer data also point to a slowdown in inflationary pressure. This explains why interest rate and inflation expectations decreased between mid-June and the end of August, ultimately shoring up bond and equity markets.
Even though the Fed kept in September the autopilot for tighter monetary policy on, arguments for peak Fed “hawkishness” are emerging. In particular economic data is coming in weaker in the US, indicated by our business cycle model.
Lately, even the robust labor market showed its first signs of slowing. This should translate into lower interest rate and inflation expectations, which typically mean a steeper yield curve, based on the short end. Both our bond and our equity allocation model see this as a good thing, especially over the term spread.
According to this, bad economic news is a good sign as market participants assume that the Fed will ease its restrictive monetary policy in the future – even though representatives from the Fed and the European Central Bank at the annual central bank meeting in Jackson Hole were reminiscent of former Fed Chairman Paul Volcker’s extremely restrictive monetary policy.
It thus remains to be seen how the Fed will respond to sustained weak economic data combined with declining inflation and whether it will be willing to adopt a potentially “painful” cycle of interest rate hikes.
Our models are signalling reasonable doubt, as long as bad news for the economy is good news for the equity market. Given this, it seems that there is still scope for a new bear market rally to emerge in a not-too-distant future.
Sven Schubert is senior investment strategist at Vontobel. The views expressed above should not be taken as investment advice.