?Cheap-Money? market bubble and geopolitical risks

The bear market

Rising interest rates, high inflation, the war in Ukraine and a slowdown in China’s economy have led investors to reconsider what they’re willing to pay for a wide range of stocks, from high-flying tech companies to traditional automakers. Since the beginning of the year 2022 big swings on the stock market have become commonplace. The last bear market happened just two years ago, but this would still be a first for those investors that got their start trading on their phones during the pandemic. Thanks in large part to extraordinary actions by the Federal Reserve, stocks have for years seemed to go largely in only one direction: up. The “buy the dip” rallying cry after every market slide has grown fainter after stinging losses and severe plunges in risky assets like cryptocurrencies. Bitcoin fell below $23,000 on Monday. The price for Bitcoin neared $68,000 late last year.

What makes investors’ mood so sour?

First, the interest rates. The US Federal Reserve is now highly focused on fighting inflation. In May inflation in the USA rose 8.6% compared to May 2021 – the highest rate since decades. The Federal Reserve also signaled additional rate increases of double the usual amount if inflation exceeds market expectations. As we see continuing price increases, the probability of even more aggressive tightening increased significantly. Similar situation we also see in the EU region. We foresee that if inflation continues to increase, the ECB will raise interest rates much more aggressively in September 2022 and going forward. Russia’s war in Ukraine has also put upward pressure on inflation by pushing up commodities prices to new highs. And worries about China’s economy, the world’s second largest, have added to the gloom.

Second, consumer behavior is changing in response to rising prices. The purchasing power of consumers started to weaken, and this trend will likely accelerate in the coming months.

Third, business sentiment is weakening. Ongoing problems with covid-infections, supply chain disruptions – all these factors add to the slowing manufacturing and industrial production.

Stock markets entered bear territory. The most recent bear market for the stock markets ran from February 19, 2020, through March 23, 2020. However, this bear is likely to be bigger and will differ from the covid-based bear market, and we should expect ongoing downtrend in stock prices (mainly due to extensive overvaluation – the bubble in the stocks, given the upward moving yields).

What should investors do in such market environment?

If investors need money urgently, they have no other way, but just sell their holdings and realize losses. We, however, would not advise to do that, especially, if investors do not need invested money urgently. It may take some longer time for the stock holdings to recover. This is the situation when the proper risk management and much more active portfolio management comes to the first place, to help reduce losses and lock in profits.

How long it may take for this bear market to last?

There is no precise answer to this question because there are many factors that influence the macroenvironment and investor sentiment. Proper monetary policy of central banks may not be able for 100% to cope with such geopolitical risks like the Ukraine-Russia conflict. There should be other measures introduced. For instance, policies to secure supply chains; policies to increase energy security. Historical experience shows that bear markets take on average 13 months to go from the pick to trough and 27 months to get back to the breakeven. History shows that the faster an index enters a bear market, the shallower they tend to be. Historically, stocks have taken 8 months to fall into a bear market. The longest bear market lasted 61 months and ended in March 1942.