For anyone watching their portfolios — or near retirement — this is stressful.
But there’s a bright side, of sorts: bear markets tend to scare away the inflation crushing investors today.
“Equity bear markets have one hidden positive: they always bring lower US inflation,” DataTrek’s Nicholas Colas wrote on Tuesday.
Though this might be cold comfort to an investor that bought stocks when the S&P 500 was 4,766 at the end of 2021, it’s a potential light at the end of the tunnel for those less exposed to markets but very exposed to the rising costs of living.
Looking at historical precedent, Colas pointed to 1973 to 1974, 2000 to 2002, and 2008 markets, noting that in the first and last instances, “PCE inflation fell by 6% during/right after a +35% decline for the S&P 500.”
The reason why this happens is simple. When people’s portfolios are fat, they feel rich and feel comfortable spending. But, Colas wrote, “the wealth effect cuts both ways, after all. When consumers see their net worth noticeably drop, their aggregate demand should decline as well.”
“On top of that,” Colas continued, “companies with plunging stock prices don’t tend to hire a lot of new workers or grant large pay raises. Wage inflation, a serious problem over the last 6 to 12 months, should start to moderate.”
And while DataTrek’s use of “always” suggests certainty, the amount of inflation relief isn’t clear. However, the current rate of inflation is in-line with drops seen in 1974 and 2008, as PCE inflation in April topped 6%.
Another elephant in the room, of course, is DataTrek’s reference to a 35% drop. The S&P 500 may be down about 22% so far this year, but 22% is not 35%. So: does the index need to get there — or trade to 3,118 from a level of around 3,710 today — for investors to find relief from inflation? Fortunately, Colas says no.
“While we have not yet seen stock prices decline by 35 percent, history says we may not need that entire move (or the economic contraction it presages) to get inflation under control,” Colas wrote.
In Colas' view, as a recession becomes the consensus view among investors, the full 35% drop in the stock market that prices in this recession may not come to pass.
"While we do not think we are at the lows for the year, it is getting easier to connect the dots regarding where stocks might bottom," Colas wrote. "As investors grow comfortable that valuations reflect an economic slowdown and recession-level earnings, markets should stabilize."