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Why Is the Market in Bear Territory?

Mon May 23, 2022

Commentators on the current state of equity markets have no shortage of explanations. Here is a brief list, which is by no means complete:

 

Cumberland Advisors Market Commentary - Why Is the Market in Bear Territory by Robert Eisenbeis, Ph.D.

 

 

 

  1. War in Ukraine – now in month four
  2. Inflation – headline CPI up 8.3% y/y
  3. Fed tightening – target funds rate at 0.75%-1.0% and a least two more 50-basis-point increases projected
  4. Interest rates: Treasury rates have moderated as investors move to Treasuries to protect capital while muni rates move up to 4% tax-free and mortgage rates hit 5% for 30-yr.
  5. Spike in oil prices – up 70% in last 12 months
  6. Slowdown in China – Q1 GDP growth 4.8%
  7. Supply chain disruptions
  8. Excess inventories – grew in response to supply chain issue but then proved to be too large as Q1 sales slowed
  9. Disappointing performance by retailers – many major retailers, including Target
  10. Big tech reversing as Covid recovery continues


There is probably some truth in each of these explanations, and it is also the case that many of these causes are interdependent. For example, the war in Ukraine clearly triggered the spike in oil prices and in agricultural prices as well. Inflation, interest rates and Fed policy are linked. Similarly, supply chain disruptions, the slowdown in China, and big-tech reversals are all Covid-related.

Clearly, most market declines have a trigger, and the two most likely events were the war in Ukraine and the Fed’s announcement to begin tightening to fight inflation. There is probably also a more convenient way, using few words, to describe the current market environment as filled with uncertainty with no good way of calibrating the probabilities of possible outcomes and investor sentiment, which is now focused exclusively on risk and what can go wrong.

In such bear market times, with the S&P now down by some 20% and NASDAQ down about 30%, we at Cumberland feel the focus should be on opportunities as the market nears a bottom, and we have identified areas that show some promise, including pharmaceuticals, transportation, and semiconductors. We also believe that there are some underlying strengths in the US economy that have not been present in other downturns. For example, the labor market is exceptionally strong, with job creation averaging 552,000 per month over the past year. There are now about two job openings for every unemployed person seeking work. Additionally, corporate and bank balance sheets are strong, with companies having taken advantage of low interest rates leading up to and during the pandemic to refinance debt at extremely favorable rates. Finally, the inventory accumulation on the part of retailers, mentioned earlier, may put downward pressure on prices going forward, lowering the need for the Fed to be as aggressive in raising rates as it may presently be planning, thereby reducing the risk of a Fed-induced recession.

The bottom line right now is that it is time to focus not only on downside risks but also on opportunities and to move cautiously, taking advantage of investments such as tax-free munis, whose yields on high-quality securities are approaching 7% taxable yields, depending upon state tax rates; and Treasury inflation-protected securities (TIPS).  TIPS are yielding about 9% and are fully guaranteed by the US government, with the caution that yields are adjusted every six months for changes in the CPI and can change rather rapidly.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


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