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How Experts Think About Bear Market Opportunities

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Bear Market Opportunities

How Experts Think About Bear Market Opportunities

Today, the majority of Americans are worried a bear market is looming.

The good news: there are silver linings. Bear markets can present bargains for investors, thanks to inefficient pricing and fear in the market. Going further, many investing greats have made key investments during market downturns including:

  • Warren Buffett: Automotive sector during the 2008 Global Financial Crisis
  • Shelby Davis: Financial sector during the 1997 Asian Financial Crisis
  • Peter Bernstein: Gold during the 2000 Dot-Com Crash

In this infographic from New York Life Investments, we show four quotes on bear market opportunities and the data behind their insight.

How Experts Think About Bear Market Opportunities

When faced with the challenges of a bear market, how do experts respond?

1. “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”

— Warren Buffett, CEO of Berkshire Hathaway

Just like a bargain on socks may be an opportunity for buyers, a bargain on stocks is an opportunity for potential upside. In fact, the S&P 500 Index has seen double-digit gains 85% of the time after extremely pessimistic sentiment since 1987.

Investor pessimism can be measured by a ‘bull-bear spread’. This is based on an AAII survey that measures investor expectations for the market in the next six months. It is calculated by taking the percentage of investors who are ‘bullish’ on the market minus those who are ‘bearish’.

For example, in the week of April 29, 2022:

  • Bullish: 16.4%
  • Bearish: 59.4%
  • Bull-Bear Spread: – 43

Here’s how the S&P 500 Index performed after periods of extreme investor pessimism:

DateBull-Bear SpreadS&P 500 Index
12-Month Return
10/19/1990-5426%
3/6/2009-5167%
10/5/1990-4422%
9/21/1990-4325%
11/16/1990-4321%
4/29/2022-43?
8/17/1990-4118%
1/11/2008-39-36%
3/14/2008-39-41%
8/31/1990-3823%
2/21/2003-3735%
10/16/1992-3614%
7/9/2010-3625%
9/14/1990-3521%
10/26/1990-3526%
2/20/2009-3544%
4/12/2013-3514%
12/21/1990-3417%
7/21/2006-3424%
1/25/2008-34-38%

Source: Bloomberg, 5/12/22

As the above chart shows, investor pessimism is at its highest in 20 years.

Instead of thinking of how bad the market is doing, investors may be better of thinking of the market as being significantly less expensive.

2. “History provides crucial insight regarding market crises: they are inevitable, painful, and ultimately surmountable.”

Shelby Davis, founder of Shelby Cullom Davis & Company

Bear markets hurt. On the bright side, they only account for 29% of the market environment, with bull markets making up the lion’s share (71%). What’s more, stocks have spent the vast majority of time at or near their all-time highs.

Market EnvironmentDescription% of Time in Market Environment
All-Time HighStock market hits all-time high35%
Bull Market DipStock market falls under 10% from all-time high33%
Bull Market CorrectionStock market falls over 10% but less than 20% from all-time high3%
Bear Market DrawdownStock market falls over 20% from peak to trough10%
Bear Market RecoveryTime it takes to reach next all-time high19%

Source: Morningstar Direct, PerformanceAnalytics, UBS 4/30/2022. Based on monthly returns from 1945.

Overall, stocks have spent around two-thirds of the time at or near all-time highs.

3. “The most important lesson an investor can learn is to be dispassionate when confronted by unexpected and unfavorable outcomes.”

— Peter Bernstein, economist and financial historian

To avoid falling for the behavioral pitfalls of a market cycle, investors can identify key macro indicators of each stage. Below, we show the economic indicators and how they associate with each type of market cycle.

Market CycleMonetary Policy Shock*Consumer SentimentEmploymentSalesPurchasing Managers Index (PMI)
BullPositivePositivePositiveHighly PositiveHighly
Positive
CorrectionPositiveNegativePositiveNegativeNegative
BearPositiveHighly
Negative
Highly NegativeHighly NegativeHighly
Negative
ReboundHighly
Negative
PositiveNegativeNegativeNegative

Source: Goulding, L. et al., May 2022. *Represents an unexpected move in monetary policy.

As the above table shows, bear markets are associated with low consumer sentiment, high unemployment, low corporate sales, and weak manufacturing performance—with a high number of macroeconomic shocks.

4. “A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.”

— Winston Churchill, former Prime Minister of Britain

Just like bear markets can stoke investor uncertainty, rising interest rates can cause stock market disruption. However, since 1954 the S&P 500 Index has returned an average 9.4% annually during Fed rate hike cycles.

Fed Rate Hike CycleS&P 500 Index Annualized Total Return
Aug 1954 - Oct 195714%
Jun 1958 - Nov 195924%
Aug 1961 - Nov 19667%
Aug 1967 - Aug 19694%
Mar 1972 - Jul 1974-9%
Feb 1977 - Jun 198111%
Mar 1983 - Aug 198413%
Jan 1987 - May 198916%
Feb 1994 - Feb 19954%
Jun 1999 - May 200010%
Jun 2004 - Jun 20068%
Dec 2015 - Dec 20188%

Source: Morningstar, Haver Analytics, March 2022

Not only that, the S&P 500 Index has had positive returns 11 out of 12 times during periods of rising interest rates. Despite the short-term impact to the market, stocks often weather the storm.

Finding Bright Spots

In summary, it is helpful to remember the following historical characteristics of a bear market:

  • Extreme pessimism
  • Short-lived
  • Higher macroeconomic shocks (employment, sales, PMI)

Investors can find opportunities by considering a contrarian point of view and learning from the time-tested experience of investing legends.

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Infographics

Europe’s Energy Crisis and the Global Economy

Europe’s energy crisis could last well into 2023. Here’s how the energy shock is causing ripple effects across the broader economy.

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Europe’s Energy Crisis and the Global Economy

Volatile energy prices are squeezing household costs and business productivity in Europe.

While energy prices have fallen in recent months, several factors could influence price volatility looking ahead:

  • Russia slashing energy supplies
  • Rising winter heating demand
  • Shrinking European storage facilities

In the above infographic from New York Life Investments, we show the potential impacts of Europe’s energy crisis on consumers, businesses, and the wider global economy.

1. Impact on Consumers

Energy plays a central role in overall inflation. Here’s how it factors into the consumption baskets of various countries:

CountryEnergy %
of Inflation
Total Inflation Rate
(Sep 2022)
EnergyFoodAll Items Less Food
and Energy
Germany46%9.9%4.5%1.8%3.6%
Italy42%8.7%3.7%2.2%2.8%
Japan42%3.0%1.3%1.0%0.8%
France29%5.6%1.6%1.6%2.4%
United Kingdom28%8.8%2.5%1.3%5.0%
U.S.17%8.2%1.4%1.0%5.8%
Canada15%6.8%1.0%1.3%4.5%

Source: OECD (Oct 2022). Annual inflation is measured by the Consumer Price Index.

As the above table shows, energy makes up nearly half of consumer price inflation in Germany. In the U.S., it contributes to about one-fifth of overall inflation.

Amid energy supply disruptions, U.S. winter heating costs are projected to rise to the highest level in a decade. As heating costs rise, it could impact consumer spending on discretionary items across the economy, along with other essential household bills.

2. Impact on Business

Natural gas and petroleum are key components in many industries’ energy consumption. As a result, the recent rise in energy prices is adding significant cost pressures to operations.

Below, we show how four primary sectors use energy, by source:

U.S. SectorPetroleumNatural GasRenewablesCoalElectricity
Transportation90%4%5%0%<1%
Industrial34%40%9%4%13%
Residential8%42%7%0%43%
Commerical10%37%3%<1%50%

Source: EIA (Apr 2022). Figures represent end-use sector energy consumption in 2021.

In Europe, soaring energy prices have led to production declines in energy-sensitive industries over recent months. As a ripple effect, European fertilizer production capacity has decreased as much as 70%, crude steel capacity has fallen 10%, and aluminum and zinc production capacity has sunk 50%.

In response, some companies may move production out of Europe to regions with lower energy prices. This occurred in 2010-2014 amid high European energy prices, where companies relocated to the U.S., the Middle East, and North Africa.

3. Impact on the Economy

While the energy crisis is having devastating effects on many countries, some markets like the U.S. are more sheltered from the impact. As seen in the table below, the U.S. produces virtually all of its natural gas. Figures are shown in trillion cubic feet.

YearU.S. Natural Gas
Production
U.S. Natural Gas
Consumption
Net Imports
20213531-4
20203331-3
20193431-2
20183130-1
201727270
201627271
201527271
201426271
201324261
201224262
201123242
201021243

Source: EIA (Sep 2022).

By contrast, Europe imports 80% of its natural gas, primarily from Russia, North Africa, and Norway. Not only that, natural gas imports have increased over the last decade, up from 65% of total supplies in 2010.

Meanwhile, the energy sector is seeing strong returns supported by higher oil and natural gas prices, along with key fuel shortages as Russia constricts supplies to Europe. In November the S&P 500 Energy Index was up 65% year-to-date compared to the broader index, with -17% returns.

Europe’s Energy Crisis: Looking Ahead

Given the complex geopolitical environment, Europe’s energy crisis could last well into 2023, driven by many factors:

  • Rising demand from China post-COVID-19 lockdowns
  • Lower European fuel reserves
  • Inadequate energy infrastructure in the medium-term

The good news is that European government relief has reached €674 billion ($690 billion) to cushion the effect on households and businesses.

However, this has additional challenges as increasing money supply may be an inflationary force.

Amid market volatility, investors can avoid getting caught up in short-term market movements and stay focused on their long-term strategic allocation.

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Infographics

5 Key Questions Investors Have About Inflationary Environments

This infographic explores questions on today’s inflationary environment as the economy faces persistent price pressures.

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Inflationary Environment

This infographic is available as a poster.

5 Key Questions on Inflationary Environments

What does a changing inflationary environment mean for financial markets, and how could this impact investors?

While there are no clear answers, the above infographic from New York Life Investments looks at key questions on inflation and the potential implications looking ahead.

1. What Are the Main Factors Driving Inflation?

Often, investors closely watch core inflation since it doesn’t factor in volatile energy and food prices. In September, core inflation rose 0.6% from the previous month while headline inflation, as represented by the Consumer Price Index, increased 0.4%.

DateCore InflationHeadline Inflation
Sep 20220.6%0.4%
Aug 20220.6%0.1%
Jul 20220.3%0.0%
Jun 20220.7%1.3%
May 20220.6%1.0%
Apr 20220.6%0.3%
Mar 20220.3%1.2%

Source: Bureau of Labor Statistics, 10/13/22.

Earlier in the pandemic, surging second-hand car prices and supply-chain distortions were factors driving up inflation. But as dynamics have shifted, rising services costs, including housing, have played a significant role.

Along with these factors, a strong labor market is adding to price pressures. Nominal wages increased 6.3% annually in September, after hitting almost 7% in August, the highest in 20 years.

For this trend to reverse, unemployment levels may need to rise and interest rates may need to increase to cool an overheating economy.

2. What is the Effect of Fiscal Stimulus on Inflation?

In response to a historic crisis, the U.S. government allocated over $5 trillion in fiscal stimulus. The Federal Reserve released research that suggests that the fiscal stimulus contributed to 2.5 percentage points in excess U.S. inflation.

Specifically, the fiscal stimulus affected supply and demand dynamics, stimulating the consumption of goods. At the same time, the production of goods didn’t increase, which elevated demand pressures and price tensions.

As the short-term implications begin to unfold, the longer-term structural effects of record stimulus remain far from clear.

3. How Do Interest Rates Impact Inflation?

When inflation is running high, the Fed often hikes interest rates to cool an overheating economy.

Consider how in February 1975 there was a 17% difference between core inflation and real interest rates, an instance when the Fed got “behind the curve”. This shows that the real rate is far below the core inflation rate.

Sometimes, this prompts the Fed to raise rates to combat inflation. After several rate hikes, inflation fell to 4% by 1983, bringing the real rate and core inflation closer together. The table below shows when this gap rose to the double-digits between 1974 and early 2022:

DateCore InflationReal RateDifference
Oct 197410.6%-0.5%11.1%
Nov 197411.0%-1.5%12.5%
Dec 197411.3%-2.8%14.1%
Jan 107511.5%-4.4%15.9%
Feb 197511.9%-5.6%17.5%
Mar 197511.3%-5.8%17.1%
Apr 197511.3%-5.8%17.1%
May 197510.3%-5.1%15.4%
Jun 19759.8%-4.3%14.1%
Jul 19759.1%-3.0%12.1%
Jan 198012.0%1.9%10.2%
May 198013.1%-2.2%15.3%
Jun 198013.6%-4.1%17.7%
Jul 198012.4%-3.4%15.8%
Aug 198011.8%-2.2%14.0%
Sep 198012.0%-1.1%13.1%
Oct 198012.2%0.7%11.6%
Dec 20215.5%-5.4%10.9%
Jan 20226.0%-6.0%12.0%

Source: Peterson Institute for International Economics, Federal Reserve Bank of St. Louis, 03/14/22. The real policy interest rate is the Federal Funds Rate minus Core Inflation over 12 months.

In January 2022, this gap reached 12%, hinting towards further interest rate action from the Fed.

Over the last 11 tightening cycles since 1965, six resulted in soft landings and three resulted in hard landings. Whether or not the recent tightening cycle will result in a hard landing, also known as a significant decline in real GDP, remains an open question.

4. How Long Will Inflation Last?

From the vantage point of 2022, the direction of inflation is as complex as it is uncertain. Below, we show where inflation may be headed in the near future based on analysis from the Federal Reserve.

 2022P2023P2024P
PCE Inflation5.4%2.8%2.3%
Federal Funds Rate4.4%4.6%3.9%

Source: Federal Reserve Board, 09/21/22. Reflects median projections for PCE Inflation and the Federal Funds Rate.

By 2024, inflation is expected to fall closer to the 2.0% target amid higher interest rates. What other key factors could influence inflation going forward?

 2023 Projection
U.S. Real GDP Growth1.2%
Interest Rates4.6%
Housing Price Growth-10.0%
Unemployment Rate4.4%

Source: Federal Reserve Board 09/21/22, Morningstar, 08/07/22. Interest rates represented by the Federal Funds Rate. Housing Price Growth represented by median U.S. home prices.

A combination of slowing GDP growth, higher interest rates, decreasing housing prices, and higher unemployment could potentially dampen inflation leading into 2023.

5. What May Lessen the Impact of Inflation On My Portfolio?

During inflationary periods, value stocks have tended to perform well, based on data from Robert Shiller and Kenneth French. In fact, value stocks saw nearly 8% annualized outperformance over growth during the 1970s and over 5% outperformance during the 1980s.

Similarly, tangible assets like commodities and real estate have tended to weather these periods thanks to their ability to increase portfolio diversification and stability across economic cycles. For instance, between 1973 and 2021, commodities have averaged 19.1% during inflationary periods while real estate assets averaged 5.0%.

The Big Canvas

Generally speaking, periods of high inflation over history are quite rare. Since 1947, the average U.S. inflation rate has been 3.4%.

Inflation (1947-2021)Percentage of Time Spent
Below 0%16%
Between 0 and 5%57%
Between 5 and 10%20%
Above 10%7%

Source: CFA Institute, 07/19/21.

Against a changing environment, investors may consider balancing their portfolios with more defensive strategies that have been historically more resistant to inflation.

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