by Philip Pilkington
Tuesday, 14
June 2022
Analysis
16:29

Will a bear market lead to a new financial crisis?

The worst is yet to come
by Philip Pilkington
We have entered bearish territory

Yesterday the news broke that the S&P500 — which tracks the largest 500 publicly traded companies in the United States — entered a bear market. A bear market occurs when the stock market falls 20% or more from its peak. Such a fall often, but not always, indicates that larger declines may be in the pipeline.

The fall comes as investors wake up to the grim reality of inflation. For a long time, investors had been shrugging off the possibility that inflation might be here to stay. They assumed that it was due to pressures on the economy that were caused by the reopening from the lockdowns.

In fact, the lockdowns have permanently impaired our supply chains. In addition to this, the sanctions we imposed following the Russian invasion have backfired spectacularly and added yet more pressure to our energy markets, food markets and supply chains. The result is embedded inflation — and investors are having a hard time denying this reality.

Now that the markets have woken up to these uncomfortable facts, centrals banks are reacting by raising interest rates to curb inflations. But given that inflation is so virulent, the interest rate hikes will be aggressive and will likely tip an already fragile economy into recession.

The most likely outcome from this is a collapse in stock prices. What does this mean for investors and for the economy?

The implications for the economy are straightforward enough. A fall in stock prices will worsen the coming recession. People with robust stock portfolios are confident and ready to spend money on consumption goods. If their portfolio has gone to the dogs, they tend to retract spending. Such a decline in spending will exacerbate recessionary forces.

But the implication for investors is arguably more profound. The most important component of society’s investment capital comes from our pension funds. These funds are deployed to stock and bond market to generate returns and ensure that we can live comfortably in retirement. If the stock market collapses, it looks like we are facing a pension crisis — perhaps even one of unprecedented proportions.

Bearish investors have been modelling this outcome for some time. John Hussman, for example, calculated that if markets were as overvalued as he expected and they eventually crashed, capital allocated to the standard pension fund portfolio in 2021 would return -2% every year for 12 years. The typical assumption pension fund managers make is that for a fund to pay out its recipients, it should be growing around 6% a year.

Think about that: 12 years of -2% returns, at the end of which £100 invested in 2021 will be worth around £80. And this analysis does not even factor in the inflation we are now experiencing which further worsens investment outcomes from the point-of-view of actual, spendable money. This is so vastly lower than the assumed 6% growth rate that a crisis is all but inevitable.

If this occurs, it will be nothing short of a disaster. It is not at all clear exactly what pension funds and the government will do. We might wait around and see if markets rapidly return to normal — but this is rare after a crash. More likely we will start to see sad headlines appear in the newspapers of people who, through no fault of their own, see the money they thought they were ferreting away for retirement disappear.

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J Bryant
J Bryant
1 month ago

This is the worst case scenario I’ve worried about for several years, especially since governments threw such huge amounts of money into their economies.
Governments have been kicking the can down the road since the dot com bust of 2000. Low interest rates and poor lending standards have fueled first a property bubble (popped in 2008) and now a general asset bubble.
Assuming the situation plays out in the way the author describes, what is to be done about it? I don’t know the answer to that question but I’m sure it will be a slow process that probably involves rebuilding our productive economy, such as high-tech manufacturing, and not just creating another bubble courtesy of financial engineering. Maybe the author can write an article discussing possible routes out of this mess.
Good luck everyone. It looks like we’re about to face much more consequential issues than trans ideology in the near future.

Prashant Kotak
Prashant Kotak
1 month ago

This is not quite so straightforward. Inflation also means a ramp in the price of many types of assets, for example commodities are sure to rise – oil, heavy metals, even grains etc. And all those are more often than not packaged the form of…. stocks. So in the first instance you get a balancing off as investors rotate out of some classes of stocks and into others. What is coming is a depressed global stock market lasting a couple of decades, but not just yet – perhaps 18-24 months away. The trigger I will look for, is when joblessness starts to rise. Until then, I suspect stocks will yoyo around.

Jim R
Jim R
1 month ago
Reply to  Prashant Kotak

The asset bubbles that formed since governments started printing money were the first indicators of the declining value of our money. The trillions they created from thin air had nowhere to go. Cynical political decisions to only measure inflation based on a highly manipulated consumer price index allowed them to hide and deny the destruction they were unleashing on the economy. Recent events should prove to anyone that modern monetary theory was dangerous nonsense and Milton Friedman was right. But as long as the people who told us inflation was transitory still control the narrative, there will be no such admission.

Last edited 1 month ago by Jim R
Nicky Samengo-Turner
Nicky Samengo-Turner
1 month ago
Reply to  Prashant Kotak

v good!

R Wright
R Wright
1 month ago

An expression about a certain animal coming home to roost springs to mind. The media and the public demanded CPC style draconianism in March 2020 and this is their just reward. A collapse in living standards is now inevitable. You will eat the bugs.

Jim R
Jim R
1 month ago

I think ‘sad headlines’ may be a significant understatement. Add a self inflicted economic collapse like this to the existing toxic and fractured political climate and its a recipe for revolution. When the economic pain hits the people who were already living hand to mouth, they will look for people to blame. It may be the extreme left or the extreme right who seize the initiative and take power. The scapegoats have all been identified. As the Leonard Cohen song goes, “I have seen the future, brother: It is murder”

Prashant Kotak
Prashant Kotak
1 month ago
Reply to  Jim R

I would agree with you expect for two things; geriatric generations don’t revolt, and there are more of those around than the hapless and fragile Gen-Zee’s. So boomers won’t revolt and the young don’t have the skillsets or the numbers or the wealth to revolt.

Last edited 1 month ago by Prashant Kotak
Jim R
Jim R
1 month ago
Reply to  Prashant Kotak

I didn’t really mean that kind of revolution. Extremist elements will take control of the mainstream political parties. Pretty sure that’s already happening.

Nicky Samengo-Turner
Nicky Samengo-Turner
1 month ago
Reply to  Jim R

spot on!

Kat L
Kat L
1 month ago
Reply to  Jim R

“Give me crack and a**l sex
Take the only tree that’s left
And stuff it up the hole
In your culture
Give me back the Berlin wall
Give me Stalin and St. Paul
I’ve seen the future, brother
It is murder”

Jim R
Jim R
1 month ago
Reply to  Kat L

“When they said “Repent!”, I wonder what they meant?”

Nicky Samengo-Turner
Nicky Samengo-Turner
1 month ago

It is unfortunately more complex than this: the advent of derivatives, indexed and tracker funds have made the old ” supply/demand/ price/ value/ p/e ” macros, all but redundant. One only has to look at the peverse reality of Tesla being worth many times Toyota, to see this. Actually pension funds are way more exposed to bond markets that have the inbuilt ” cap and collar” of coupon v pricing that move in inverse directions, and are far more stable as a result, but are affected by rising interest rates.
There will be a post summer equity markets crash, Sept- oct 2022, due to the fact that the equity is like a railway.. no matter how modern, it still has steel wheels and runs on a track and is 19th Century, and will be hanmered by 21st C instruments that reflect a fear of more real economic decline in the US and Europe, due to appalling politicians, trade protectionism, an inbalance of labour supply/demand/ pricing, and the internet distortion of supply and demand of goods, causing a very different type of ” specific area” inflation, that is not macro. QE, and Crypto will add to the fire….. but The Far East/ Asia will not be similarly affected, and as history shows, the transfer of real economic power there will continue.