With stock markets rallying since June, then crashing again with worse-than-expected inflation data, it’s been tough to make heads or tails of this bear market. But then wild, short-term swings like these never send very clear signals. So I’ve looked at what Goldman Sachs’s strategists have said about past bear markets and isolated the key points to help you navigate this one…
1. We are in a cyclical bear market.
When things are going south, it’s important to differentiate what type of bear market you’re in, as this can impact the length and shape of the recovery. Broadly speaking, there are three types of bear markets – event-driven, structural, and cyclical. Event-driven bear markets are caused by a one-off “shock” like war, an oil price disruption, or even a pandemic. Structural bear markets are usually the result of an economic imbalance or major bubble correction, like the 2008-09 recession. And cyclical bear markets, like the one we’re currently in, are typically triggered by rising interest rates, impending recessions, and declines in profitability.
Structural bear markets have historically been the worst in terms of depth of declines, length, and time to recovery. However, history would tell you it’s wise not to get your hopes up yet about this one. Cyclical bear markets generally fall around 30%, last an average of two years, and take around five years to achieve a return to their previous highs. That means that we could be in for a long ride.
2. It’s not time to buy the dip yet.
The market’s rally in mid-June caused many people to question whether we had reached the trough and whether it was time to buy. But Goldman’s strategists say it’s too early for that, since we’re only at the “hope” phase of the investment cycle. See, there are generally four distinct phases in this cycle – despair, hope, growth*,* and optimism. The hope phase usually lasts an average of 10 months and occurs when the market anticipates a trough in the economic cycle and a rebound in future profit growth. Before you get too excited about the next rally, it’s worth keeping in mind that bear market rallies are common – and you’ll need to see a few more signs before you can get optimistic.
3. The odds favor a hard landing.
Part of the reason why it’s not yet time to buy the trough is this: we haven’t yet seen or priced in the full impact of higher interest rates on the economy. It’s not yet clear whether the US will avoid a recession, achieving what’s called a soft landing. In fact, the historical odds of a soft landing in the US after a cycle of interest rate hikes are low: 11 out of 14 tightening cycles since World War II were followed by a recession within two years.
And as the chart below also shows, these odds fall further when inflation is high. In inflationary environments like the current one, monetary tools like raising interest rates tend to be less useful since today’s inflationary pressures are driven more by supply-side issues, rather than demand.
A hard landing meanwhile will be tough for investors. While market sentiment tends to be negative and stock valuations tend to tank, or “de-rate”, in both soft and hard landing scenarios, the scale and length of the de-rating tend to be deeper and more persistent in a hard landing.
4. There are four signs to look out for before a recovery.
While not a perfect measure, there are four signs you need to look out for before you can reasonably expect a recovery: cheap valuations, a slowing in deterioration of the economy, a peak in interest rates and inflation, and negative positioning. Valuations tend to fall as investors anticipate a recession, and although cheap valuations may be a necessary condition preceding a recovery, they alone aren’t enough to signal that one is on the way.
You’ll also need to see shoots of improvement in the economy. Stock markets tend to do better when growth is weak but improving than they do when growth is strong but slowing. Most bear markets trough around six to nine months before a recovery in corporate earnings, and that can only come when we’re close to a peak in interest rates and inflation.
At present, this seems to be hardly the case: the Federal Reserve (the Fed) shows no signs of pivoting away from its aggressive rate hiking cycle, and inflation is still likely to see further headwinds from Europe’s energy crisis. Lastly, as they say in investing, it’s all about expectations and what’s priced in. A recovery is usually preceded by extremes in investor positioning and sentiment – you’ll need people to expect the worst before you can start being optimistic.
5. The next bull market is likely to be fatter and flatter.
Without ultra-low interest rates to drive ever higher valuations, investment returns are likely to be weaker in the post-recovery stage compared to the recent secular bull run. This also explains why Goldman Sachs believes returns over the next decade will be “fatter and flatter”, with a wider trading range and lower returns. This will change how you pick winners for the next decade, including focusing less on top-line growth and looking for companies competitively positioned with strong margins and cash generation to sustain dividends. We detail more about how investing might look like in the new cycle here.
What does this mean for you?
Markets are constantly changing, and today’s bear market might look very different compared to those of yesteryear. Still, you may find these historical observations helpful as a starting point in determining where we are in the cycle and when it’s time to be optimistic. In the meantime, you may want to equip yourself with a strategy that allows you to do well regardless of the situation, and contemplate some time-tested advice from the sages you can consider to get you through this bear market.
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