Stocks crash? No, but that’s why this bear market is so painful – and what you can do about it.

Hashtags about the stock market crash may be trending on Twitter, but the sell-off that drove US stocks into a bear market was relatively orderly, market specialists say. But it will likely become more volatile – and painful – before the market stabilizes.

It was indeed an articulate journey for investors on Friday like the Dow Jones Industrial Average (DJIA),
-1.62%
It fell more than 800 points and the S&P 500 SPX index,
-1.72%
It traded below its lowest close in 2022 since mid-June before paring losses before the bell. The Dow fell to its lowest closing level since November 2020, putting it on the verge of joining the S&P 500 in a bear market.

Why is the stock market going down?

High interest rates are the main culprit. The Federal Reserve is raising the benchmark interest rate in historically large increases – and plans to keep raising them – as it tries to bring inflation back to its 2% target. As a result, Treasury yields rose. This means that investors can earn more than in the past by depositing money in government papers, which increases the opportunity cost of investing in riskier assets such as stocks, corporate bonds, commodities or real estate.

Historically low interest rates and ample liquidity provided by the Fed and other central banks in the wake of the 2008 financial crisis and the 2020 pandemic helped drive demand for riskier assets such as stocks.

That solution is part of the reason why selling, not limited to stocks, is so tough, said Michael Aaron, chief strategist for the SPDR business at State Street Global Advisors.

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They suffer from the idea that stocks are going down, bonds are going down, and real estate is starting to suffer. In my view, it’s a fact that interest rates are rising very quickly, which leads to declines across the board and volatility across the board,” he said, in a phone interview.

How bad is that?

The Standard & Poor’s 500 Index ended Friday down 23% from its record close of 4,796.56 set on January 3 this year.

This is a big dip, but it’s not out of the ordinary. In fact, it’s not as bad as a typical bear market pullback. Analysts at Wells Fargo studied 11 bear markets for the S&P 500 since World War II and found that overdrafts, on average, It lasted 16 months and produced a negative 35.1% return for the bear market.

Brad MacMillan, chief investment officer at Commonwealth Financial Network, said in a note.

He wrote: “Big dips are a regular and recurring feature of the stock market.” “In this context, this is no different. Since it is no different, as with any other drop, we can reasonably expect the markets to rebound again at some point.”

What awaits us?

Many market veterans are preparing for more volatility. The Federal Reserve and its Chairman, Jerome Powell, indicated after the September meeting that policy makers intend to continue raising interest rates aggressively next year and not lowering them until inflation falls. Powell warned that controlling inflation would be painful and require a period of economic growth without the general trend and high unemployment rates.

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Many economists argue that the Fed cannot drive inflation without plunging the economy into recession. Powell noted that a severe recession cannot be ruled out.

“Until we get clarity on where the Fed is likely to end its ‘rate-raising cycle,’ I expect more volatility,” Aron said.

In the meantime, there may be more shoes to drop. Analysts said the third-quarter corporate earnings reporting season, which begins next month, may provide another source of downside pressure on stock prices.

“We are of the opinion that the 2023 earnings estimates should continue to decline,” Ryan Grabinsky, investment analyst at Stratigas, wrote in a note. “We have the odds of a recession in 2023 at about 50% right now, and in a recession, profits are down 30% on average. Even with some extreme scenarios – like the 2008 financial crisis when profits fell 90% – it’s still average The drop is 24%.”

Estimates of 2023 earnings are down just 3.3% from their June highs, Grabinsky said, “and we believe those estimates will be revised lower, especially if the odds of a recession in 2023 increase from here.”

What do I do?

Sticking with high-quality dividend-paying stocks will help investors weather the storm, Aron said, as they tend to perform better during periods of volatility. Investors can also look to approach historical benchmark weights, using the benefits of diversification to protect their portfolio while waiting for opportunities to put money to work in riskier parts of the market.

But investors need to think differently about their portfolios as the Fed transitions from the era of easy money to a period of high interest rates, and as quantitative easing gives way to quantitative tightening, as the Fed shrinks its balance sheet.

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“Investors need to focus on thinking about what might benefit from monetary tightening,” he said, such as value stocks, small-cap stocks and bonds with shorter maturities.

How will it end?

Some market watchers argue that while investors have suffered, the kind of complete capitulation that typically characterizes market bottoms has yet to materialize, although Friday’s sell-off did at times carry a whiff of panic.

Sharp interest rate increases by the Federal Reserve have triggered market volatility, but they haven’t caused a disruption in credit markets or anywhere else that would give policymakers pause.

Meanwhile, the US dollar remains on the rampage, having surged over the past week to multi-decade highs against major rivals in a move driven by the Fed’s policy stance and the dollar’s position as a safe place to pause.

Breaking the unrelenting dollar rally, Aaron said, “would suggest to me that the cycle of tightening and some fear – because the dollar is a haven – has begun to decline.” “We don’t see that yet.”

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