Recession Vs. Bear Market In The S&P 500 And Dow Jones

Key takeaways

• On Monday, the S&P 500 closed in a bear market for the first time since March 2020
• The Nasdaq Composite has been in a bear market for a few weeks now, while the DOW
  is approaching one
• A bear market represents a 20%+ decline from recent highs and can precede a recession
• That said, recessions are economic (not stock) downturns, and they don’t always go hand-in-hand with bear markets

The stock market fell into bear territory Monday as investors grappled with disappointing news that may herald an impending recession. In particular, the S&P 500 declined 3.9% in Monday’s session, hitting its lowest level since March 2021. This marks the first time the S&P 500 has wandered into bear country since February 2020.

The 2022 stock sell-off intensified as investors approach this week’s key Federal Reserve meeting. Fed officials are expected to hike interest rates at least 0.5% to combat rising inflation. But recent events have many pricing a 0.75% hike into their portfolios – and worrying that when it comes to a recession vs. bear market, investors are safe from neither.

S&P 500, meet bear market

Prior to Monday’s close, the last market-wide bear market happened two years ago when the pandemic kicked off. But since then, actions taken by the Federal Reserve to prop up the economy have also proved healthy for stocks. Rock-bottom interest rates, pro-market quantitative easing, and a tech boom off the work-from-home revolution all contributed to soaring prices.

But last year, inflation accelerated following key product shortages. Investors began to fret that some companies were far overpriced for their fundamentals, while others struggled to repeat their record-high pandemic profits. And while market participants “bought the dip” during the initial decline, many have since retreated as losses mount.

Now, almost a full year after inflation began rising, the S&P 500 – containing 500 of the largest market cap companies in the United States – has fallen into a bear market. As a common barometer of corporate health, the S&P’s plight has many concerned for what lies ahead.

What is a bear market?

A bear market occurs when stocks fall at least 20% from recent highs. However, this number is largely arbitrary and primarily serves as the marker at which investors feel queasy about their portfolio performance. Mathematically, there’s nothing special about the cutoff beyond its effect on investor psychology – and that it occasionally precedes economic recessions.

In less-specific terms, a bear market is a steep, sustained stock market downturn that chips away at accumulated gains. Technically, single stocks or funds can march into bear country, though when we say “the market” has fallen, we generally mean the S&P 500 or another large benchmark.

A disastrous day

The S&P 500 has flirted with – but not closed below – a bear market for a while now, dipping below 20% intraday. But many believe the market isn’t “officially” a bear market until an index closes below 20%. And Monday, that’s just what happened.

On the day, the S&P 500 tumbled nearly 4%, clawing losses from its record January high down over 21%. Meanwhile, the Dow Jones slipped 2.8% to settle 17% below its recent record, while the Nasdaq Composite tumbled 4.7% to sit down 33% YTD. (The Nasdaq, egged on by declining tech values, has squatted in bear territory for a few weeks now.)

Admittedly, the market has been on a downswing for a while now. But Monday was particularly nasty, as at one point, every single stock in the S&P index dipped, with only a handful closing in the green. Meanwhile, the CBOE Volatility Index (VIX), or “fear index,” spiked to its highest level since May.

Causes of the current bear market

Arguably, the current bear market is overdue, as several causes have piled up to contribute to the market’s decline. In particular, Monday’s decline occurred after news outlets suggested that the Fed could hike interest rates by 0.75% on Wednesday instead of the expected half-point increase.

But why?

That news stems from Friday’s inflation report, which found that inflation rose 8.6% year-over-year in May after previously showing signs of slowing. Even excluding food and energy prices – which are notoriously volatile – inflation leapt a whopping 6% YOY.

That said, it takes more than a single inflation report to send the market squalling into bear country. Wall Street has buckled under multiple causes for concern recently, including:

• Sky-high inflation
• Rising interest rates
• The Russia-Ukraine War
• China’s slowing economy
• And soaring gas prices, to name a few

As investors and consumers have grappled with worrying indicators on these fronts, worries of a recession have loomed large in many minds. And when consumer and investor confidence falls, it’s not uncommon for the markets to buck a bit lower.

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Recession vs. bear market: key differences

Although bear markets and recessions can – and often do – go hand-in-hand, they’re usually caused by separate (albeit linked) activities. That’s because the stock market and the economy, while often linked, are actually separate financial structures.

A recession is an economic slowdown traditionally defined as at least two consecutive quarters of declining GDP, or gross domestic product. The causes of recessions can vary, including:

• Loss of consumer confidence driving lower spending
• Poor business performance that leads to fewer hires
• High interest rates
• High inflation
• Housing and credit crises

Meanwhile, a bear market takes place only in the stock market. Often, a bear market kicks off when falling returns push investors to sell out, triggering further pessimism that acts as a negative feedback loop.

The stock market can be a leading indicator for the economy as a whole. This means that a bear market can sometimes be a warning signal that the economy is going to feel negative impacts like falling GDP, rising unemployment, low consumer confidence, spending, and income. However, this isn’t always the case.

It’s easy to see how the ingredients that kickstart a bear market can also lead to a recession. However, it’s rare for the bear market itself to cause a recession.

But what isn’t unheard of is for the Federal Reserve to take actions that contribute to recessionary environments – and that’s some of what we’re seeing right now.

The Fed’s role

Unfortunately, two of the biggest factors that can lead to a recession are playing against each other right now. And because it’s the Federal Reserve’s job to address both of them, they’re stuck between a rock and a hard place with no dynamite in sight.

The math is this:

Sky-high inflation, which we’re currently experiencing, can send the economy into a recession-style shutdown.

But the Fed’s main tool to combat inflation involves increasing interest rates, which discourages consumer and corporate spending and stunts business growth – which, predictably, spooks employers, consumers, and investors alike.

In other words, the Fed’s main tool to yank the rug out from under exorbitant prices is also what’s scaring investors and consumers, leading to worries that fighting inflation could be what pushes the economy into a recession.

There’s no way to pull a guaranteed win in our current economic situation. Inflation can’t charge on forever without serious economic consequences. But many have predicted that the Fed’s increasingly aggressive rate hikes could prevent the U.S. economy from a “soft landing” off its inflationary highs.

While exact expectations differ depending on who you talk to, many believe that the U.S. will have what Fed Chair Jerome Powell dubbed a “soft-ish landing.” In other words, high interest rates will either lead to no recession or a mild recession, followed by a relatively quick recovery.

With a strong labor market on his side, it’s possible he’s right. That said, even if the Fed manages to tamp inflation without triggering a recession, investors may still have to contend with the downward pressure on their portfolios.

How long will the bear market last?

It’s impossible to accurately predict how long the S&P 500 will remain in a bear market. But what is clear is that they’re a periodic – if anxiety-inducing – feature of healthy stock markets.

For instance, between World War II and 2021, the S&P 500 declined at least 20% no less than nine times and at least 40% an additional three. While the largest bear markets took around five years to bounce back from, the market recovered in an average of 14 months from bear market lows.

And the last bear market, which occurred in early 2020, lasted just a few weeks – with the S&P 500 growing at a blistering annualized rate of 53% off the back of it.

Responding to a bear market

When the stock market tanks, it’s tempting to sell out, especially if you’re feeling a pinch in your wallet. But you’re more likely to lock in losses – that is, selling stocks at a loss and guaranteeing your portfolio won’t have a chance to recover.

That’s why, for most investors, the best course of action is to just stay put. Riding out the waves can cause a bit of anxiety, but even bear market-style price swings are relatively normal in the financial markets. And in fact, taking advantage of a diving market can be a great way to buy quality stocks at a substantial discount.

That said, it’s still important to ensure you’re making smart moves, such as using dollar-cost averaging, taking advantage of AI-backed portfolio rebalancing, or buffing your returns with dividend-paying stocks. Additionally, you may increase your holdings in investments like consumer staples and healthcare, whose business model can potentially prove more resilient to economic downturns.

Does the S&P 500 bear market signify a recession?

There’s no real way to tell if the current market decline heralds a recession or not. Though investor and consumer anxiety about rising interest rates is real, reliable indicators of recession – including the near-term forward spread and Sahm rule – show no signs of impending doom.

Still, there’s no harm in being prepared (in fact, it’s foolish not to). That’s why we here at Q.ai have put together a variety of AI-backed Investment Kits to prep your portfolio for whatever comes your way. From our Large Cap Kit, which benefits from the long-term macro view that U.S. GDP growth will be slow, to the Inflation Kit, which can help hedge against rising prices, you can protect your portfolio on multiple fronts.

And for added security, you can turn on Portfolio Protection to help manage risks in these turbulent times.

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