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Understanding Recessions and Bear Markets

Understanding Recessions and Bear Markets

May 02, 2022
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The economy and the stock market have both performed poorly since the start of the year, but does that mean we are in an economic recession or a bear market? It’s a matter of speculation and no one can definitively answer the question with the current data. Let’s take a closer look at what define and differentiate the two, and most importantly, what it means for your portfolio.  

A recession is two or more consecutive quarters of negative Gross Domestic Product (GDP). The GDP for the first quarter of 2022 unexpectedly contracted -1.4% versus the estimated +1% growth. Many economists don’t believe we are in a recession and the current economic numbers are transitory. The fact that many professionals are dismissing the GDP data gives the contrarian in me pause to consider the possibility that we may be currently in a recession. In early 2021 the Federal Reserve thought that inflation was going to be transitory, and they were quite wrong. If the economy is in a recession the stock market is most likely in the middle of a bear market.

A bear market is a 20% or more decrease of a broad-based stock market index such as the S&P 500 for American stocks or FTSE All World Index for global stocks. Currently the S&P 500 is down -14% and the All World Index -15%. The Nasdaq Composite Index, a more specific and thus more volatile index, is down -24% and is currently in a bear market. The Nasdaq isn’t representative of the broader market and so we don’t yet want to label the broader market as being in bear market territory.

A recession is an economic event while a bear market is a stock market event. Although the economy and the stock market influence one another, economists and investors don’t fully understand if an economic recession starts a bear market or if it’s the other way around. It is known however that the stock market bottoms out and begins its rebound before the economic recession reaches its low point.

In the next few months there will be enough data to determine if we are currently in a recession and bear market. The last one occurred in Q1 and Q2 of 2020, and both the drop and the rebound occurred quickly over a matter of months. These events can be of much longer duration, 1-3 years, but I believe this is a lower probability event given that the economy is in the middle of an economic expansion cycle.

Currently, the best course of action for stock portfolios is to maintain a globally diversified portfolio and not sell positions in fear. Stock market rebounds can occur quickly, at any time, and selling out of fear can cause a portfolio to miss the growth of a rebound. It’s also a good idea to save extra cash and be ready to invest it if the market declines further. I will keep you informed in our weekly market update emails, and I will also send out a buying opportunity alert if the S&P 500 declines to around -20%, or as market conditions dictate.

Photograph by: Sean Benesh on Unsplash

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