Like a bear with a sore head, many investors probably wish they had stayed in hibernation in 2022. It has been a brutal year so far, the worst since the Great Depression nearly a century ago.
Capital destruction, in other the words the amount of money wiped off the value of investments, stands at more than $9 trillion globally, exceeding the financial crisis of 2008.
Most major stock markets are in bear market territory. A bear market typically describes a condition in which prices of investments fall 20% or more from their recent high.
Crypto investors have suffered even more. The global value of all crypto currencies currently stands at just over $900 billion, down from $2.9 trillion at its peak in late 2021.
The trigger: increasing concerns the economy is barrelling towards “stagflation” - where slowing economic growth combines with accelerating inflation – or a global recession, as central banks raise interest rates and rein in money supply trying to tame spiralling inflation. The result – carnage in financial markets.
In these six charts we tell the story of the 2022 bear market so far and what investors might do next.
The battle to tame inflation
Central banks have been forced into action as inflation in most major economies has already hit 40-year highs and continues to rise. It’s brought about stark reminders of the dark days of the 1970s and early 1980s, often called the Great Inflation.
This time it’s been exacerbated by pent-up demand following the end of Covid lockdowns in most major economies, combined with supply constraints caused by Covid lags in Asia and war in Ukraine.
The result is inflation near double-digits around the world and it continues to surge. The main problem is the rising cost of energy, up 70% in 2022, which affects everything from production to consumption. But across the board commodities are up nearly 30%.
Chart 1: The rise in commodity prices
Sources: Schroders. Refinitiv data for Barclays commodity indices correct as at 20 June 2022.
Past Performance is not a guide to future performance and may not be repeated.
No major stock market left unscathed
The worry for investors in stocks is that the more persistent inflation becomes, the more drastic the measures that central banks will take to contain it. If central banks don’t manage the process properly, it could lead to stagflation or even a recession - which would spell bad news for consumers and company profits.
The result has been a rout in stock markets which has been brutal, broad-based and unremitting. From the US to China, developed economies to emerging, most stock markets are down over 15% so far in 2022, with many over the 20% bear market threshold.
Chart 2: The bear market for stocks in 2022
Past Performance is not a guide to future performance and may not be repeated.
Crypto in crisis?
In environments like these, the riskier the investments, the harder they fall. And the crypto currency market has fallen further than most.
The global crypto market has lost more than two-thirds of its value since November 2021. But most of the losses were sustained after March 2022 following the collapse of one of its supposed stable coins, terraUSD. Terra was supposed to maintain a $1 peg but a run on the coin broke the pegging mechanism and investors’ confidence. It is now worth one cent.
Terra’s tribulations have had a ripple effect across the crypto markets. Bitcoin, the leading light of crypto, is now worth around $20,000, down from its all-time high of nearly $69,000.
Chart 3: The fall of bitcoin
Past Performance is not a guide to future performance and may not be repeated.
Source: Schroders. Refinitiv data correct as at 20 June, 2022.
Does a bear market signal a recession?
The big question though is: just because investors are panicking, does it mean the economy will enter a recession? Let’s take a look at the world’s biggest economy, the US, for an answer.
While Schroders’ economists are not currently forecasting a recession in the US, the risks are skewed towards one. Investors can take some comfort that recessions don’t necessarily follow a bear market. That said, the odds are not favourable looking back at history.
Since the 1900s, the US economy has only managed to avoid a recession 30% of the time when a bear market has occurred.
Looking ahead, the longer the sell-off lasts for and the deeper the fall in prices, particularly against a backdrop where the Federal Reserve is hiking interest rates, then the higher the risk of a recession.
Chart 4: Do bear markets signal recession? 1900 to 2022
Which stocks might perform best (and worst)?
Unfortunately, it’s not just a recession investors are worried about. There is the increasing the risk of stagflation – stagnant growth, high inflation.
Stagflation tends to favour defensive companies, whose products and services are essential to people’s everyday lives, over cyclical companies, whose products aren’t. In other words, consumers ignore the new iPhone, because they need to pay the electricity bill.
This means the share prices of defensive stocks tend to hold up better than cyclical stocks when the economy slows, as shown in the table below. The only exception being energy stocks.
This makes sense as the revenues of energy stocks are naturally tied to energy prices, a key component of inflation indices. By definition they should perform well when inflation rises.
In technical terms, defensive sectors have a market beta of less than 1 (meaning they outperform when the index falls), whereas cyclical sectors have a market beta of greater than 1, (they underperform when the index falls),
This is illustrated in the table below, which displays the average historical return of 11 global economic sectors versus the MSCI World Index in stagflation environments.
Chart 5: How stocks perform during stagflation
When might stock markets recover?
Again we look to US for the answer. There have been 11 occasions in the 148 years between 1871 and 2019 when stocks (as measured by the S&P 500 Index) have destroyed at least 25% of value for investors. In 2001 and 2008 downturns, losses exceeded 40%.
In the worst case, the Great Depression of the 1930s, investors lost over 80% of their money. It took over 15 years for them to make their money back – if they remained invested.
Other stock market falls were not quite so calamitous. In seven of the 11 episodes, investors would have recouped all losses in two years or less if invested in the S&P500 index. In the other four – 1893, 2001 and 2008 – the period to break-even was four to five years.
Chart 6:How long did US stocks take to recover losses from a 25% crash?
Past Performance is not a guide to future performance and may not be repeated.
Source: Robert Shiller, Schroders. Monthly data 1871-2020. Data is for S&P 500 and assumes investors retained their exposure to the stock market.
