Stocks enter bear market, grim signal of economic fears

Three weeks ago, Wall Street narrowly escaped a bear market, with stocks rebounding at the last minute from a sharp drop that sent the S&P 500 down 20% from a record high in January. The following weeks offered a glimmer of hope that the worst of the losses might be over.

That glow is now gone.

On Monday, the S&P fell 3.9%, ending the day nearly 22% below its Jan. 3 high and firmly in a bear market — a rare and bleak marker of growing investor concerns for the economy.

A crucial report released on Friday showed that inflation in the United States was accelerating and creeping into all corners of the economy. Early last week, the World Bank issued a stark warning that global growth could be stifled, especially as the war in Ukraine drags on.

Together, the data undermines optimism that the Federal Reserve, by raising interest rates, would be able to control price gains without hurting the US economy and sending ripples around the world.

Monday’s trading ended with reports that the Fed is likely to discuss its biggest interest rate hike since 1994 when policymakers meet this week.

“The Fed needs to raise policy rates more aggressively if it has any hope of lowering inflation,” said Seema Shah, chief global strategist at Principal Global Investors. “If it is to tighten even more, then the risk of a recession is higher.”

Big stock declines like this — only the seventh bear market in the past 50 years — usually accompany a tectonic shift in the outlook for the economy and hit people’s retirement accounts. Although one does not cause the other, recessions have always followed bear markets. The last time stocks fell this much was at the start of the coronavirus pandemic, and before that was during the 2007-2008 global financial crisis, which toppled some of the world’s biggest banks.

The 2020 bear market only lasted a relatively short six months, however. Stock analysts fear that this decline will drag on.

Concerns about the US economy weighed on stock markets in Australia, Japan and China, which all opened lower. In Australia, the key stock index fell 5% on Tuesday morning, plunging to its lowest levels in two years. Japan’s Nikkei stock index fell 1.6% and China’s Shanghai Composite index fell about 1% in early trading.

Stocks are now falling because businesses and consumers face rising costs almost everywhere they turn and investors fear the Fed will hit the economy as it tries to tame inflation. The central bank has already raised interest rates twice this year, and Wall Street is bracing for interest rates – which were near zero in March – to rise to 3% by September. The last time the federal funds rate was this high was during the Great Recession.

The tightening of higher policy rates trickles down through the economy to make borrowing of all kinds – from mortgages to corporate debt – more expensive. This slows the housing market, prevents consumers from spending and discourages business expansion.

But interest rates are a blunt tool and their impact on the economy is delayed, making it difficult for the Fed to know if it has gone too far before it is too late.

“The moment you start to understand and realize that you’ve done too much, you’re going to be at the bottom of a bottom,” said Dan Genter, managing director of Genter Capital Management, an investment advisory firm. “It’s going to take nine to 12 months before you see the full effects, and it takes that long to get out.”

Borrowing costs are rising as gasoline hits $5 a gallon and rising food prices, rents and house prices begin to weigh on households, Genter added. This in turn hurts consumer spending, which has long been a key driver of the US economy.

“My fear is that fundamentally the Fed is going to really tighten too much and potentially push us into a severe recession,” he said.

Monday’s selloff – the worst daily decline in a month – touched many corners of the financial markets. All major US equity sectors ended lower, as did benchmarks in Europe and Asia. Oil prices and government bonds also fell. And Bitcoin fell below $24,000, an 18-month low. The cryptocurrency has lost about half of its value this year.

On Wednesday, the Fed is expected to release its latest economic projections, which investors are likely to watch closely. They can be reassured if the central bank forecasts a path of higher interest rates more moderate than expected.

But for investors to really stop worrying, they’ll need to see inflation ease in the coming months, said Lauren Goodwin, economist and portfolio strategist at New York Life Investments.

Another unanswered question for investors is the impact of the Fed’s other policy change. After buying government bonds to help maintain liquidity in the financial system, an emergency measure that began at the start of the pandemic, the central bank is backtracking.

“This is a major wild card for investors,” Ms Goodwin said.

A second leg of the market downturn is likely yet to come, Ms Shah said. Stocks could fall further as economic troubles show up in corporate earnings, consumer spending and other data that show the worst expectations for the economy are coming true. The new wave of selling might not happen before the end of this year.

All the talk of recessions and bear markets could also – at least at the margin – add to economic pressure, in part because people see their investment, retirement or college savings accounts dwindle and begin to reduce their expenses.

“The behavioral effect is people will start to slow down their spending, become a lot more cautious, start saving more,” said Beth Ann Bovino, chief U.S. economist at S&P Global. “It’s not a good result for the economy. It slows growth.

The report was provided by Alexandra Stevenson, Jason Karaian, David Yaffe-Bellany, Clifford Krauss, Ben Casselman, Eshe Nelson, Melina Delkic and Isabelle Simonetti.