On Monday, June 13, investors began the week by digesting a new spate of unwelcome news. Inflation continues to surge. The stock markets sank. The S&P 500 now resides in bear market territory.
A bear market, as you may remember, is a drop of 20% or more from a recent peak. In this case, the “recent peak” was all the way back on January 3 of this year.
I get paid to help 401(k) investors navigate bear markets. I have seen several in my 36 year investment advice career.
But not all bear markets are the same. Some are long, some are short. Some come with economic recessions and others do not. Some catch investors completely unawares.
For this reason, it is better to focus on the reasons behind the number rather than the number itself. Concentrate on the cause instead of the effect. That way, a bear market does not seem so abstract or bewildering.
Breaking Down the Bear
This current bear market is not a surprise. The gradual stock market decline has been going on since the start of the year. Driven by one thing: Inflation.
Recently, the Federal Reserve raised interest rates by a half-point.
The hope was that this step – the first of its kind since the year 2000 – would start slowing inflation’s rise.
Unfortunately, a half-point was not enough. On Friday, June 10, a new Consumer Price Index report showed that inflation rose even higher in May, to the tune of 8.6%. That is the biggest increase since 1981.
The Federal Reserve now has a choice. Raise interest rates and risk triggering a recession. Or continue the same measured path and risk worsening inflation.
The latter strategy has been the Fed’s choice for months. Now, the pressure to get it right is even greater. Both approaches come with short-term pain for the stock markets. Which is why Friday’s news was the tipping point for a bear market.
On the one hand, higher interest rates are a proven tool for fighting inflation. Higher interest rates reward saving overspending.
If Americans spend less, demand for goods and services goes down. Forcing companies to lower their prices if they are to attract new business. Lower prices, of course, means lower inflation.
But higher interest rates mean higher borrowing costs. And more expenses for both individuals and companies. If rates rise too high, too fast, it could trigger nationwide layoffs, a crash in housing prices, and more.
Still, many economists expect the Fed to announce even larger rate hikes soon. Because of inflation and because the economy may be able to manage it.
If you remove inflation from the equation, the economy is in good shape. The unemployment rate is at 3.6%, which is back to where we were in January 2020 before COVID hit.
And consumer spending – the bedrock of our economy – remains strong. It was to shore up the economy that the Fed dropped interest rates in the first place.
The Fed meets this week to discuss their next move. And the markets will have more clarity after that about what the immediate future holds. What kind of price movement will that clarity prompt?
It is anyone guess. If the Fed announces bolder action, that could help reassure investors. And pull the stock markets out of bear territory.
Depending on how the Fed words its guidance, it is possible the bear takes an even bigger bite out of stock prices.
Which is why we need to prepare for either result. The headlines are important. But and how we react to them will play a significant role in navigating these turbulent times.
The real danger during market conditions like these is not the bear itself, but the way people respond to it.
What a Bear Market Means
Have you ever been driving on the road and hit every green light on the way to your destination? It is a great feeling, isn’t it? Well, that’s sort of what a bull market is – and the road is the journey to your financial goals.
A bear market is the opposite.
During a bear market, the near future, is like getting caught at every red light in a major traffic jam. We are still progressing toward your goals, but we are inching instead of cruising. Sometimes, we may not move at all for a while. Sometimes, it may be necessary to take a detour and backtrack.
Bear markets are like rush hour traffic. The lane you are in will not budge. Meanwhile, the lane next to you seems to be moving fine. So, as soon as you see an opening, you merge into that lane – only to immediately slam on your brakes.
Now the new lane stops. So, you try again…until you find yourself in the closed lane. The lane causing a traffic jam in the first place.
This is what emotional, undisciplined investors do during bear markets. They start trying to change lanes, get off the road, or even abandon the car altogether. As a result, they burn fuel, waste time, and end up making the situation worse. Because they are not where they need to be when the road gets cleared and the traffic speeds up again.
They are not there when the bear market ends, and a new bull is born.
You see, history does not show us how long a bear market will last. Until now, we have had three bear markets in the 21st century.
The first, in the early 2000s, lasted 929 days. The second, amidst the Great Recession, lasted 517. But the third, back in early 2020, lasted only 33.
What history does show us is that bear markets are always temporary. The stock markets always recover. And the recovery can be a generational chance to get in the next bull market on the ground floor.
Remember what a bear market means and does not mean. Turn the volatility into our advantage in the long run.
Because while a bear market may signal the end of a bull, it does not signal the end of your 401(k) investment strategy.
Because, at the end of the day, we prepared for this. Your 401(k) has a money market balance. And you are ready to take full advantage of the current stock market “sale.”
A bear market just means we might have to sit in traffic for a while.
Ric Lager
Lager & Company, Inc.
