EC When Is The Next Bear Market? 3 Things Will Tell

The question I get most often is, “when is the next bear market?” Three specific items tend to predict bear markets and recessions with some accuracy.

However, before we get to those points, a “bear market” requires excesses that need reversion. In other words, a mean-reverting event needs “fuel.” Several measures suggest excesses are sufficient to fuel a meaningful reversal.

Deviation From Long-Term Means

Next Bear Market, When Is The Next Bear Market? 3-Things Will Tell You

Household Equity Ownership

Next Bear Market, When Is The Next Bear Market? 3-Things Will Tell You

Margin Debt

Next Bear Market, When Is The Next Bear Market? 3-Things Will Tell You

Importantly, none of these measures mean a “bear market” is imminent. Instead, it requires a catalyst to cause a change in sentiment from “greed” to “fear.”  As noted, three indicators historically denote when the “clock starts ticking” to the next bear market.

Yield Curve

The yield curve is one of the most important indicators for determining when a recession, and a subsequent bear market, approaches. The chart below shows the percentage of yield curves that invert out of 10-possible combinations.

Investors should never dismiss the message sent by the bond market. Bonds are essential for their predictive qualities, which is why analysts pay an enormous amount of attention to U.S. government bonds, specifically to the difference in their interest rates. Why is this?

Unlike stocks, there is a finite value to bonds. At maturity, the lender receives the principal along with the final interest payment. Therefore, bond buyers are aware of the price they pay today for their return tomorrow. Unlike an equity buyer taking on “investment risk,” a bond buyer is “loaning” money to another entity for a specific period. Therefore, the “interest rate” takes into account several “risks:”

  • Default risk
  • Rate risk
  • Inflation risk
  • Opportunity risk
  • Economic growth risk

Since the future return of any bond, on the date of purchase, is calculable to the 1/100th of a cent, a bond buyer will not pay a price that yields a negative return in the future. (This assumes a holding period until maturity. One might purchase a negative yield on a trading basis if expectations are benchmark rates will decline further.)

Therefore, since bonds are loans to borrowers, a bond’s interest rate is tied to the prevailing rate environment at the time of issuance.

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Mike Nolan 4 weeks ago Member's comment

Good, informative read, thanks.