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If we do get a bear market, or just come close, the current slide could well be a head fake, and not signal a near-term recession. The unpleasantness of late-2018 may well turn out to be a non-event, like the 2011 bear market, which looked bad at the time, yet didn’t lead to a recession. Trouble is, this most recent malaise likely is telling us a scarier story, long-term.
First, though, let’s look at the nervous-making climate we find ourselves in. Investors are getting whipsawed this year.
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Since its September peak through Christmas Eve Day, the S&P 500 had lost 19.8%, just a hair’s breadth away from the 20% that marks a bear market. This was the second correction of the year—that’s when the market dips by 10%—and scared a lot of people. When the market turned around on Wednesday and advanced almost 5%, investors felt like they’d been granted a stay of execution.
What’s vexing is that there’s no guaranteeing that stocks won’t plunge anew in coming days. The market’s wall of worry is getting steeper: the seemingly irrational trade war, the slowing of economies around the globe (a.k.a., our trading partners, who will be buying fewer American goods and services), the Brexit mess, the euro zone’s tiff with Italy, etc.
And then there are our homegrown worries: That an impetuous President Donald Trump will get the U.S. embroiled in a catastrophe, or that the Federal Reserve’s rate-raising campaign will go too far and choke off the nine-year-old economic recovery. Not to mention the proximity of an inverted yield curve,
Should we actually get another bear market, the drop won’t necessarily portend an imminent recession. A look at 2011 shows how that can work out.
Back in 2011, the world was transfixed by the debt imbroglio in southern Europe, particularly in Italy (sound familiar?), Spain and, worst of all, Greece. And Germany, the leader of the euro block as the Continent’s biggest economy, was reluctant to bail out what its saw as the euro zone’s profligate Mediterranean members.
The world was just two years removed from the financial crisis. So nerves were really on edge, and a lot more than now. Making matters worse, Standard & Poor’s lowered Washington’s credit rating by a notch due to a fiscal imbroglio between the Obama White House and Republicans in Congress (the GOP had won control of the House a few months earlier).
Stock stumbled into a bear market, with the S&P 500 losing 21.6% from its apex. Investors braced for another double-dip recession.
But that didn’t happen in the U.S. Gross domestic product growth slipped a bit, to 3.65% from 4.2% in 2010. After a similar growth picture in 2012, GDP resumed its climb. Even more telling, unemployment nicked up a by only a small amount, to 9.9% in 2011 from 9.8% the year before. But come 2012, joblessness shrank again, to 8.3% and has been dropping ever since.
The previous head fake bear market started in October 1987, when stocks lost 33.2% in one day. War worries with Iran were one reason. During the down spell, other problems kicked up, such as the savings and loan crisis, brought on largely by imprudent real estate loans the S&Ls had extended. Yet investors eventually shrugged those woes off, and by mid-summer 1988, the bull market kicked in anew.
As the old saying goes, the stock market anticipates the future. The market can be wrong, however. If you cashed in your stock holdings amid the 1987 and the 2011 bear markets, you would have lost out on big gains in the run-ups that rapidly followed.
These days, none of this is to say that a recession isn’t coming at some point. The consensus has been that this will occur in 2020. Whatever the date, a look at the two recent head fake bear markets shows that they did give off signals of what eventually would become big problems. Both involved heavy and unwise levels of debt, whether by Greece or by American S&Ls.
Prediction: When the next recession finally does arrive, debt also will be the culprit. Enormous masses of debt are sitting out there, growing ominously. Federal debt, corporate debt, consumer debt, public pension debt, student debt—you name it, trillions of dollars are owed that no one is sure can be repaid. Italy’s clash with the euro zone is an early signal. Leeriness about the Fed’s actions is another.
When the day of reckoning comes, a bear market will develop and the ensuing recession will be a whopper.