From the beginning of the 20th century until this year, the U.S. has seen several bear markets that lasted for months. In the past year, a rising number of investors have been anticipating another market downturn, prompting some of them to make bearish bets. But Richard Bernstein, chief executive and chief investment officer at Richard Bernstein Advisors, argues that these concerns are premature.

A bear market is generally defined when the indices such as the S&P 500 or Dow Jones Industrial Average fall 20% or more over a period of at least two months. Experts vary on how long bear markets last, but several say the average length ranges from 9 to 14 months. If the indices decrease by more than 10% but less than 20%, the downturn is  considered a market correction.  

According to an October report from RBA, there are three primary drivers of an impending bear market. One of them is the Federal Reserve and other central banks shrinking the amount of money in the economy by raising the interest rates. Another is a decline in corporate profits, and the last is overly bullish sentiment of investors. (See also: Digging Deeper Into Bull and Bear Markets.)

Fed and Interest Rates

Fed interest rate hikes, or more specifically increases in the Federal Reserve's funds rate, create higher borrowing costs. The consequent increase in rates on credit cards and mortgages leads to individuals to spend less. At the same time, businesses are forced to pay higher rates for bank loans. These rates increases alone can slow the economy and in turn affect corporate profits and stock performance.

Since the beginning of 2016 the market has been anticipating a second increase in the federal funds rate after raising rates in December of last year.  One of the prevailing market opinions is that the Federal Reserve might wait until the results of the November 2016 presidential election to make its next decision on monetary policy  

Falling Corporate Profits

The next indicator flagging a bear market is the decline of corporate profits. To analyze that, RBA looks at the earnings of the corporate sector as a percentage of U.S. GDP. And that ratio is the largest ever.

Also, an historical overview of the bear markets that occurred during the 20th and beginning of the 21st centuries illustrates the correlation between the economy and the percent change of the S&P 500 index.

For instance, the period from October 2007 to March 2009 was marked by the index's plunge of over 50%, fueled partly by the housing market crash in the U.S. (see chart). The previous slump, associated with the Dotcom bubble burst in 2000-2001, caused the Nasdaq Composite to decline by 78%.

 

Chart Made in TradingView 

To be sure, some analysts point to evidence that there currently is no sign of an approaching bear market, Bernstein, for example, draws attention to the appreciation of the S&P 500 by over 15% over the past year.

Market Sentiment

The third signal of a bear market, according to the RBA report, is the presence of overly bullish sentiment. Market sentiment indicates the "mood" of investors, which causes consequent price movements based on people selling or buying the stocks. The perception of the market by investors is a subjective and relative measure.

One of the indicators is the VIX, or CBOE Volatility Index, which measures the readiness of investors to take on the risk or the contrary. The VIX is widely known as the "fear" index and is usually tracked by monitoring its moving average. An abnormally low VIX index over a period time could signify the overly optimistic mindset of the market players and is sometimes considered a technical sign of an impending recession. (For related content see: Is the Stock Market Crashing? 5 signs to consider).

 

 

 

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