Shaky Stocks Send S&P 500 to the Bear Market Brink and Back

(Bloomberg) — More hair-raising volatility in the S&P 500 pushed the index within spitting distance of a 20% drop, a decline that puts markets on covers of newspapers and holds ominous meaning for the economy.

Down as much as 1.9% Thursday and 30 points from a bear market before a last-hour rally, the benchmark is now destined to decrease for a sixth straight week, something it hasn’t done since June 2011. Growing certainty that the Federal Reserve’s efforts to halt inflation will send the economy into a recession has lopped nearly $10 trillion off equity values in 18 weeks. 

While economic data and forecasts keep pointing to an expansion in measures like gross domestic product, stocks themselves become improbably prescient indicators of a recession when they complete a bear market plunge. That’s partly because of what they signal about the future, and partly what shrinking brokerage accounts do to consumer sentiment.

Fourteen times the S&P 500 has completed the requisite 20% plunge that defines a bear market in the last 95 years. In just two of those episodes did the American economy not shrink within a year: 1987 and 1966. It works the other way around, too. Among 15 recessions over the span, only three weren’t accompanied by a bear market.

You hear it a lot: the stock market isn’t the economy. But the saying loses some of its precision at a time like this. It takes a pretty violent shift in sentiment to knock the market this hard, and equity losses take a toll on consumer psychology. Also: usually the market warns something is awry long before economic growth goes negative.

The S&P 500 ended the day down 0.1% and sits 18% below its Jan. 3 all-time high. It has lost 4.7% so far this week.

Many of the bear markets since World War II had four things in common, according to Sam Stovall, chief investment strategist at CFRA. They are a rate-tightening cycle by the Fed, an inverted yield curve, geopolitical tensions and a recession that occurred within 12 months. 

“This year, the outstanding question is: do we end up slipping into a recession,” Stovall said by phone. “The Fed will likely end up engineering a recession rather than just a soft landing,” he said, adding that inflation is usually below the fed funds rate at the beginning of rate-tightening cycles, whereas the opposite is true right now.

Not everyone’s convinced. 

“We still think we’re a ways out from a recession,” Emily Roland, co-chief investment strategist at John Hancock Investment Management, said. That means “there’s a potential for the drawdown to be milder than a bear market that is associated with a recession.”

Her firm’s data back that up. Since 1950, nonrecessionary bear markets saw the selloff last 1.6 years on average, compared with four years for bear markets with an economic slowdown. The average decline in a nonrecessionary bear market was 27.4% compared with 37.6% for when a recession came with a stock rout.

Read more: Scorched Stock Traders Starting to See Hard Landing in Soft Data

Steven Ricchiuto, Mizuho Americas chief US economist, says we’re seeing the final stages of what is likely to be a significant decline for equities. Investors have come to realize that a so-called Fed put won’t be backstopping any losses. 

“Now we’re at the phase where we are starting to see bonds go down in yield and equities go down at the same time.” he told Bloomberg TV. “That’s telling us that we’re starting to get to the point where people start to downgrade their earnings numbers and that’s the final shoe that needed to fall in the equity market.”

Investors have come to terms with the idea that the market could remain choppy for much of the year. Strategists at Bank of America predict the selloff could last into October, for instance. 

Brian Nick, chief investment strategist at Nuveen, says stocks will have a hard time rallying “for quite some time” because the Fed will be raising rates throughout the summer before they’re able to re-assess how well their inflation-fighting plan is working. 

“Once we get to September, October and then at the end of the year into next year, that’s where the market is going to get a lot more clarity on how far the Fed’s going to need to go,” he said.

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