Stocks crashing? No, but here’s why this bear market feels so painful — and what you can do about it.

Hashtags about a stock market crash may be trending on Twitter, but the selloff that sent US stocks into a bear market was relatively orderly, market experts say. But it’s likely to become more volatile — and painful — before the market stabilizes.

It was indeed a thrill for investors on Friday as the Dow Jones Industrial Average DJIA,
plunged more than 800 points and the S&P 500 Index SPX,
was trading below its 2022 closing low from mid-June before paring losses before the bell. The Dow fell to its lowest closing level since November 2020 and was poised to join the S&P 500 in a bear market.

Why is the stock market falling?

The main reason is rising interest rates. The Federal Reserve is raising its benchmark interest rate by historically large strides – and plans to raise them further – as it tries to bring inflation back to its 2% target. As a result, government bond yields have skyrocketed. That means investors can make more than they could in the past by parking money in government bonds, increasing the opportunity cost of investing in riskier assets like stocks, corporate bonds, commodities or real estate.

Historically low interest rates and ample liquidity provided by the Fed and other central banks after the 2008 financial crisis and the 2020 pandemic helped boost demand for riskier assets like stocks.

That resolution is one of the reasons the sell-off, which isn’t limited to stocks, is feeling so harsh, said Michael Arone, chief investment strategist for the SPDR business at State Street Global Advisors.

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“They’ve been struggling with the idea that stocks are down, bonds are down, real estate is starting to suffer. In my view, it’s the fact that interest rates are rising so quickly that’s causing overall declines and volatility,” he said in a phone interview.

How bad is it?

The S&P 500 index ended Friday down 23% from its record close of 4,796.56 on Jan. 3 of this year.

That’s a strong pullback, but not uncommon. In fact, it’s not even as bad as the typical bear market decline. Analysts at Wells Fargo examined 11 past S&P 500 bear markets since World War II and found that the downsides lasted an average of 16 months and produced a negative bear market return of 35.1%.

A decline of 20% or more (a popular definition of a bear market) has occurred in 9 of the 42 years since 1980, or about once every five years, Brad McMillan, the Commonwealth Financial Network’s chief investment officer, said in a note.

“Substantial declines are a regular and recurring feature of the stock market,” he wrote. “In that context, this one is no different. And since it is no different, like any other decline, we can reasonably assume that markets will eventually bounce back.”

What’s coming up?

Many market veterans are bracing for more volatility. The Fed and its Chair Jerome Powell signaled after their September meeting that policymakers intend to raise rates aggressively into next year and not cut them until inflation has come down. Powell has warned that bringing inflation under control will be painful as it will require a period of below-trend economic growth and rising unemployment.

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Many economists contend that the Fed cannot whip up inflation without plunging the economy into recession. Powell has signaled that a hard downturn cannot be ruled out.

“Until we have clarity on where the Fed is likely to end its rate hike cycle,” “I would expect more volatility,” Arone said.

In the meantime, more shoes can be dropped. The third-quarter earnings season, which begins next month, could be another source of downward pressure on stock prices, analysts said.

“We believe earnings estimates for 2023 need to be lowered further,” Ryan Grabinski, investment strategist at Strategas, wrote in a statement. “We currently have our 2023 recession odds at about 50%, and in a recession, earnings fall about 30% on average. Even under some extreme scenarios – like the 2008 financial crisis, when profits collapsed by 90% – the median drop is still 24%.”

The consensus earnings estimate for 2023 is down just 3.3% from its June highs, he said, “and we believe these estimates will be revised down, especially as the likelihood of a 2023 recession increases from here.” , wrote Grabinski.

What to do?

Arone said that sticking with quality value stocks that pay dividends will help investors weather the storm as they tend to outperform during periods of volatility. Investors can also try to approximate historical benchmark weights, taking advantage of diversification to protect their portfolio while waiting for opportunities to allocate money to riskier parts of the market.

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But investors need to think differently about their portfolios as the Fed transitions from the easy money era to a period of higher interest rates and quantitative easing giving way to quantitative tightening, with the Fed shrinking its balance sheet.

“Investors need to focus on thinking about what could benefit from tighter monetary policy,” such as value stocks, small-cap stocks and shorter-dated bonds, he said.

how will it end

Some market watchers argue that while investors have suffered, the kind of full-throttle capitulation that typically marks market bottoms has yet to materialize, although Friday’s sell-off carried a tinge of panic at times.

The Fed’s aggressive rate hikes have increased market volatility but have not caused a slump in credit markets or elsewhere that has given policymakers pause.

Meanwhile, the U.S. dollar continues to rage, rallying to multi-decade highs against major peers over the past week on the back of the Fed’s monetary policy stance and the dollar’s status as a safe place to park.

A break in the dollar’s relentless rally “would suggest to me that the tightening cycle and some of the fear — because the dollar is a haven — is starting to ease,” Arone said. “We don’t see that yet.”

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