The risk is a series of bear-market rallies that don’t last, hurting dip buyers and further damaging investor confidence

https://www.wsj.com/articles/conditions-are-ripe-for-a-deep-bear-market-11653166864?mod=hp_trending_now_article_pos1

With the S&P 500 briefly on Friday down 20% from its January peak, it is very tempting to start trying to call the end of the selloff. The problem is that only one of the conditions for a rally is in place, that everyone’s scared. That worked beautifully for timing the start of the 2020 rebound, but this time around may not be enough.

The other requirements are that investors start to see a way through the challenges, and that policy makers start to help. Without those, the risk is a series of bear-market rallies that don’t last, hurting dip buyers and further damaging investor confidence.

This time central bankers are scared not by falling markets or the economic outlook, but by inflation. Sure, if something major breaks in the financial system, they will refocus on finance, and a recession may prompt them to rethink rate rises. But for now, inflation means that falling stock prices are seen merely as a side effect of tighter monetary policy, not a reason to invoke the “Fed put” and rescue investors.

There is nothing magical about a fall of 20%, the usual definition of a bear market. But it does crop up a lot: In the past 40 years, the S&P 500 has bottomed out with a 20%-or-so peak-to-trough decline four times, in 1990, 1998, 2011 and 2018. Another four times it had far bigger losses, as true panic took hold.

The common factor in the 20% drops was the Federal Reserve. Each time, the market bottomed out when the central bank eased monetary policy, with the stock market’s fall perhaps helping push the Fed to take the threats more seriously then it otherwise might.

My concern is that this time could be more like 1973-1974. Just as then, the primary concern of the country is inflation, thanks to a war-related oil-price shock. Just as then, the inflationary shock took hold when the Fed had rates far too low given the scale of political stimulus for the economy. Just as then, favored stocks—the Nifty Fifty, now the FANGS and associated acronyms—had soared in prior years.

Most important, in 1974 the Fed kept raising rates even as a recession took hold because it was running to catch up with inflation. The result was a horrible bear market interspersed with soul-destroying temporary rallies, two of 10%, two of 8% and two of 7%, each snuffed out. It took 20 months before the low was reached—not coincidentally, when the Fed finally began to get serious about cutting rates.

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To be clear, this article is not predicting a bear market, just saying that conditions are almost optimal for one to occur. The market can of course stay irrational longer than you can stay solvent if you bet against it. Regardless, Don’t Fight the Fed.