Have the you-know-what woken from their hibernation?
It’s the question on every investor’s mind at the moment.
Strictly speaking, we only talk about a b**r market when stock markets correct 20% or more. That’s not yet the case.
So technically, those big fuzzy animals are still expected to be in their dormant state.
Morgan Stanley, however, doesn’t heed the official definitions too much. In a research note to clients, the US bank’s analysts delivered that dreaded six-worded message:
“We are in a bear market.”
Perhaps we shouldn’t be too surprised to see these words uttered. Wall Street’s bull market has run for a record nine-and-a-half years.
For nearly a decade, stock markets have been in the “Goldilocks” sweet spot. The economy expanded neither too fast nor too slow, while low interest rates and central bank stimulus helped push valuations higher.
With central banks hiking rates and reducing their balance sheets, the markets may be feeling the effects.
Even though we’re not in an official bear market, Morgan Stanley analyst Michael Wilson is warning his bank’s clients:
“If it looks like a bear and trades like a bear, stop trading it like a bull.”
A Goldilocks market
In a British fairy tale from the 19th century, a little girl named Goldilocks sneaks into the house of the Three Bears.
She wreaks havoc by breaking a chair, eating the bears’ porridge, and sleeping in their beds.
Anyway, after tasting the porridge of Papa Bear, Mama Bear and Baby Bear, Goldilocks judges the baby’s food to be just right. It’s neither too hot nor too cold.
These days we speak of a Goldilocks economy when it displays the ideal conditions policymakers crave. It’s not too hot (inflation) or too cold (recession). Instead, there’s steady growth, low inflation, and low interest rates.
For 10 years Goldilocks has been the patron saint of global stock markets. Circumstances have been “just right” for markets to go up in almost a straight line.
Ultra-low interest rates and central banks buying up all the assets they could get their hands on have proved a powerful combination to bolster bonds and stocks.
But Goldilocks is growing grey.
Wall Street’s bull market has already run longer than any previous bull market on record. Though the current correction isn’t enough yet to call it a bear market, the bull’s momentum is clearly fading.
The rout in technology stocks, which were almost solely responsible for the bull market to keep moving upwards, is largely to blame.
The S&P 500 is down 8% from its September peak. The Dow Jones has fallen 7%, while the tech-heavy Nasdaq index has lost 13% of its value already.
That’s still a way off bear market territory, which is only reached once a market has fallen 20% or more from its peak.
But that’s beside the point, according to Morgan Stanley. Investors generally don’t invest in “the market” but in individual stocks.
No less than 40% of S&P 500 stocks are down at least 20%, the bank points out.
“It’s become apparent even to the casual observer that the US equity market is acting differently,” writes analyst Michael Wilson.
“Our view is that the market is sniffing out an earnings recession and a sharp deceleration in economic growth.”
Markets lose their sponsors
And then there’s the 10 trillion dollar question…
Can markets keep rising now that central banks, their biggest sponsors of the past decade, don’t just stop buying assets but actively roll back their stimulus?
Central banks bought up lots and lots of bonds, stocks, and other assets in the aftermath of the global financial crisis. It was part of their “emergency response”. An emergency that lasted nearly a decade.
The four largest central banks – the Federal Reserve, European Central Bank, Bank of England, and Bank of Japan – added $10 trillion to their balance sheets.
Together with cutting interest rates to their lowest level in history, these massive “quantitative easing” programmes propped up the financial markets.
But with economies running at full throttle, central bankers are finally confident enough to move away from their emergency policies.
Central banks are reducing their bloated balance sheets and are gradually increasing interest rates to keep inflation at bay.
You could say they’re merely doing their job, which is to keep the economy from overheating, but it’s a definite problem for the stock markets.
Morgan Stanley argues that “quantitative tightening” (central banks shrinking their balance sheets) has been the number one issue for markets all year.
“Monetary stimulus is being removed in a much more deliberate way than we have seen since 2004 and fiscal stimulus has peaked,” says Wilson.
“While 2018 is clearly not a year of recession, the market is speaking loudly that bad news is coming.”
Goldilocks has had her fun for nearly 10 years, but the Three Bears had to return sometime.
At some point, economic growth would slow, interest rates would rise too much, or geopolitical turmoil would finally spill over to the markets.
Though we’re not in an official bear market yet, it seems the bears are on their way and ready to wreak havoc.