Is the Stock Market in a Bear Market or Just Taking a Breather?

25th July 2023

Amidst market fluctuations, investors are questioning whether the stock market is entering a bear market or if it’s merely a temporary downturn. This post explores the signs and future outlook.

The stock market is often likened to a turbulent sea, and the current waves of uncertainty have left investors pondering whether they’re facing the gaping mouth of a bear market or simply navigating through a brief storm. As the saying goes, “The market can stay irrational longer than you can stay solvent,” and indeed, it sometimes appears that the market has a mind of its own. However, amidst the dramatic fluctuations, it’s crucial to take a step back, evaluate the factors at play, and ascertain whether we’re witnessing a bear market or just a temporary blip. To make this determination, let’s look at the key indicators that signal the health of the market, and the narrative that unfolds with each wave.

When stock prices fall by more than 20% from their recent highs, the term "bear market" inevitably gets thrown around. But what constitutes a bear market? More than just a slump in prices, a bear market involves sustained pessimism that leads to widespread declines across multiple sectors. However, is the current market merely in a "breather" phase, characterised by temporary corrections before continuing its upward trajectory? To answer this, we must first assess the signs that point to one or the other.

A bear market typically emerges after a prolonged period of exuberance, akin to the heady optimism of Fitzgerald’s The Great Gatsby, where excess and overconfidence fuel a temporary sense of invincibility. The crash, when it arrives, feels sudden—like Gatsby’s tragic demise—revealing the fragile nature of such unchecked optimism. At this juncture, investors look for reassurance in data and market fundamentals, but the damage to sentiment has already been done.

Current fluctuations could well be the result of a correction rather than a full-fledged bear market. A correction is defined as a drop of 10% or more in stock prices, and historically, corrections have occurred roughly once a year. However, these corrections are typically brief, lasting only a few weeks or months. In contrast, a bear market tends to persist for longer periods, often accompanied by broad economic downturns and pessimism. If history serves as our guide, most corrections recover relatively quickly as market participants regain their confidence. This is akin to the volatile but ultimately hopeful trajectory of characters in some of Dickens' works, like David Copperfield, whose constant struggles mirror the market’s frequent, yet resolute, recoveries.

Beyond the psychological factors, several economic indicators play a significant role in determining whether the market is headed for a bear phase. For instance, interest rates are one of the key drivers of market performance. Rising rates typically weigh heavily on stocks, as borrowing costs increase, reducing corporate profits and making bonds more attractive to investors. Central banks, led by the Federal Reserve, have been hiking interest rates to curb inflation, which has triggered a wave of market volatility. However, it’s important to note that interest rate hikes often precede recessions, further complicating the outlook for the stock market.

Yet, there are counterarguments. Despite the rise in rates, many companies are still posting strong earnings, and economic growth continues to show resilience. Unemployment rates remain low, consumer spending remains robust, and global supply chains are gradually recovering from the disruptions of previous years. These signs suggest that the market may simply be in a correction phase, and with the right economic policies in place, it could soon resume its upward march. The issue lies in the fact that sentiment, which often drives the market as much as fundamentals, remains shaken, clouding the prospects of a swift recovery.

In many ways, the current market is reminiscent of the themes explored in Moby-Dick, where the relentless pursuit of an unattainable goal mirrors the market’s pursuit of constant growth. Just as Captain Ahab’s obsession with the white whale leads to his downfall, the market’s quest for endless expansion without considering the risks could end in a painful reckoning. But even in Moby-Dick, there is an undercurrent of hope—despite Ahab’s tragic end, Ishmael survives, offering a glimmer of resilience that could be applied to the market. In the same way, while some industries may falter, others will adapt and evolve, guiding the market toward eventual recovery.

But beyond the broader economic indicators, one of the most critical factors in determining the market’s future is investor sentiment. Bear markets are often characterised by a collapse in confidence. When prices fall sharply, fear tends to set in, creating a downward spiral as investors sell off their holdings. This creates a feedback loop, where declining prices create further panic, and panic causes further declines. It is during these times that the adage "buy when others are fearful" takes on its true meaning.

In contrast, market corrections are often driven by more temporary factors, such as an overreaction to news or short-term disruptions in economic conditions. In these cases, while the market may experience a sharp drop, it often rebounds quickly as investors realise that the underlying fundamentals of the economy and businesses remain strong. This phenomenon is reminiscent of the characters in Austen’s Pride and Prejudice, whose initially turbulent relationships often settle into more stable and enduring connections. The market, like love in Austen’s novels, has a way of finding equilibrium, even after periods of uncertainty.

In conclusion, it is crucial to take a measured approach when analysing the market’s current state. While the signs of a bear market are certainly present, they are not yet overwhelming. The economic fundamentals that support a healthy stock market remain largely intact, and it is possible that the current fluctuations represent nothing more than a correction. However, the uncertainty of the market, amplified by rising interest rates and the shifting landscape of global economies, leaves room for caution.

Ultimately, whether the market is truly in a bear phase or merely taking a breather will depend on the coming months, as investors closely monitor the unfolding economic conditions. The market, like any great literary tale, is full of twists and turns. But like the characters of Dickens, it will ultimately find its way through the storm, provided that investors do not succumb to panic. For now, the prudent investor will watch closely, stay informed, and avoid being swept up in the frenzy of fear that often accompanies market downturns. After all, as Shakespeare wisely noted in Hamlet, "Give me that man that is not passion's slave, and I will wear him in my heart's core, ay, in my heart of heart."