Text | Barron's writer Jacob Sonenshine Editor | Guo Liqun All investors should not rule out the possibility of serious weakness in the stock market. The current consensus among the investment community is that the Federal Reserve will continue to relax policy and the stock marke

Article | "Barron's" writer Jacob Sonenshine

Editor | Guo Liqun

All investors should not rule out the possibility of serious weakness in the stock market.

It is the current consensus in the investment community that the Federal Reserve will continue to relax its policy and the stock market will not fall. However, a bear market may still occur during the implementation of monetary easing measures, and it is necessary for investors to understand what phenomena will mark the beginning of a bear market.

The Federal Reserve is doing its best to help the economy survive the crisis caused by the epidemic. The Fed said at the end of March that it would fully implement stimulus measures to achieve this goal.

The Federal Reserve currently purchases tens of billions of dollars in U.S. Treasury bonds every month to keep Treasury bond prices high and interest rates low. Investors have therefore been forced to switch to riskier bonds such as corporate bonds and mortgage bonds, and consumers and businesses have increased borrowing and spending as loan costs have fallen.

The federal funds rate, currently close to 0%, has a similar effect. Stocks have benefited because investors expect the economy to pick up and returns on fixed-income securities are very low.

As of the close on December 24, the S&P 500 index has risen 67% since hitting the low of the year on March 23. It seems that a new round of bull market has appeared.

However, Ned Davis, founder of Ned David Research, recently wrote in a report to clients, " Even if the Fed does not intend to tighten policy, a bear market may still occur." Tightening monetary policy is It refers to the Federal Reserve raising interest rates or reducing bond purchases in order to reduce inflation, which in turn leads to a decline in economic growth, demand, and stock valuations .

Davis pointed to 1962, 1987 and 2000 as examples, noting that the Fed did not tighten policy in those years but the stock market experienced bear markets. For example, in 2000 the Federal Reserve lowered interest rates, but the stock market was entering a bear market at the time. In late 2000, the federal funds rate peaked at 6.5%, but fell to less than 1% by the end of 2003. From September 2000 to March 2003, the S&P 500 fell 44%.

This is not to say that a bear market is coming. Factors such as the Federal Reserve's easing policy, the government spending package recently signed by Trump, and the economic restart after the vaccine is put into use will provide support to the U.S. economy.

The likelihood of a sudden and significant rise in inflation and interest rates is slim. Jason Pride, chief investment officer of Glenmede Personal Wealth, wrote in a research report, "Current inflation and inflation expectations remain relatively benign and below the 2.0% to 2.5% range set by the Federal Reserve."

At the same time, stock valuations are relatively reasonable.

Davis said not to "fight the Fed," but more importantly, don't "fight the current trend." The former means that investors should not sell stocks when the Federal Reserve implements monetary easing; the latter means that recent upward trends in the stock market usually indicate strong trends ahead.

Since 1968, when the Fed's easing policy created loose financial conditions and the S&P 500 index was above its 12-month moving average , the index has averaged an annual total return of 18%. When these two factors do not meet the above conditions, the average annual return drops to 4.5%.

Nonetheless, the possibility of a bear market remains.

If the S&P 500 falls 7.2% from its December 24 high of 3,702, selling stocks may be the best course of action. If it falls by 7.2%, the index will be at 3442 points.

If the index rises 8.4% from the closing level on December 24 to 4021 points, Davis recommends that investors buy. If the stock market gets a sell signal, short-term, low-yielding corporate bonds may outperform stocks, he said.

Davis doesn't mean to necessarily sell stocks, but the point is that no investor should rule out the possibility of serious weakness in the stock market.

translation | Xiaocai

Copyright statement:

Original article of "Barron's" (barronschina) may not be reproduced without permission. For the English version, see the report “A Bear Market in Stocks Could Still Happen. Here’s When to Worry.” on December 28, 2020. (The content of this article is for reference only, and the investment advice does not represent the bias of "Barron's"; the market is risky, so investment must be cautious.)