The 2022 Bear Market Cycle May Be Far From Over

Zombie hand rising out of a graveyard in creepy night

Romolo Tavani

The 2022 bear market has yet to run based on historical trends and valuations versus interest rates. The S&P 500 2022 continues to trace the bear markets of 1937, 2000 and 2008, which is more of an indication of the ebb Flow of human nature as past and future events.

The mid-August high served as another turning point for the S&P 500, leading to a new September low. At this point, the historical references of the major bear markets of the past suggest that another low is due sometime around October 25th, more or less a few days, followed by upward movement and perhaps some consolidation.

bear markets


A new low in October?

From the perspective of events that could lead to a sustained decline and bottom in late October, a better-than-feared earnings season could be one such event. Whether an end-October low will be the bottom or a short-term bottom remains to be seen, but given the high valuations, more needs to be done to reach the bottom.

It’s all about prices

The S&P 500 earnings yield for 2022 minus the 10-year real yield is currently 4.56%. Historically, this is at the lower end of the range and is associated with market tops, not bottoms. For example, the 4.5% region was visited in December 2016, January 2018, October 2018 and June 2020. The only instance where there was no significant drop was in December 2016 when the index consolidated sideways for almost three months.

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Yield Yield


Since 2014, the average spread between S&P 500 year-to-date earnings yields and 10-year real yields has been around 5.2%, with a standard deviation of 4.87% to 5.57%. Currently, the S&P 500’s premium to the 10-year TIP is more than two standard deviations from the mean. The spread would need to increase 30 basis points to bring the index back to one standard deviation, or 65 basis points to return to the historical average.

average yield


Another 9% drop?

The S&P 500 has an earnings yield based on earnings estimates for 2022 of 6.17%. A 30 basis point hike would take the yield to 6.47%, and a 60 basis point hike would take the yield to 6.77%. Earnings yield is simply the inverse of the PE ratio, meaning the current PE ratio is 16.2 and would need to drop to 15.4 or 14.7 to bring the S&P 500 back to a historical average fair value.

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With 2022 earnings estimates currently at $224.73, this would value the S&P 500 in a range of 3,460 to 3,300. That would equate to a further decline in the index of around 5% to 9%.

S&P 500 earnings estimates


Interest rates and the dollar index are more likely to tell us when this bear market is over, as these are likely to give a much better signal than other metrics. Because if interest rates keep rising, the S&P 500 must keep falling with the pace of rate hikes.

rate cuts?

Typically, the 10-year spread minus the 2-year spread tells us when the Fed is about to cut rates. The point at which the spread begins to widen usually serves as the best reference for the end of a rate hike cycle and the start of a rate cut cycle.

Fed rate cuts


As the market anticipates a rate cut by the Fed, the 2-year yield begins to fall back towards the 10-year yield. The opposite is true: the 10-2 year spread made a new low just recently in September and is showing very little if any signs of upward movement.

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10-2 common


In the meantime, the best way to determine when the 10-2 year spread will start to rise is to look at the unemployment rate, which tends to be a very good indicator of where yields are headed. When unemployment starts to rise, it usually indicates that the 10-2 year spread is about to widen, suggesting that a rate-cutting cycle is imminent.

unemployment rate


In that case, Friday’s jobs report showed that the unemployment rate fell to 3.5% and back to its July lows from 3.7% last month. That means the spread between the 10-year and 2-year Treasuries is nowhere near bottomed, and the Fed is probably nowhere near its tightening cycle.

If the Fed is far from completing its rate-hike cycle, then rates are likely not finished yet. So the stock market bear market cycle may well have to continue even if the stock market finds a short term bottom in late October.

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