A bear market with no recession? Sure
Stocks continued their decline on Tuesday, in particular the Russell 2000 index tracking small-cap stocks fell deeper into territory not seen since 2013. That benchmark is down nearly 26 percent from its high last summer, a further slide into a new bear market. The Dow Jones industrials index has limited its fall to 12.7 percent as the bulls hang on to the psychologically critical 16,000 level as if the universe depends on it.
Perhaps it really does.
Because while the U.S. economy doesn't appear vulnerable to a new recession in the near future -- recent economic data has been, soft but job growth remains strong and consumers are bolstered by cheap gasoline -- the risks of a "nonrecession" bear market are rising fast.
Yes, there really is such a thing.
The last nonrecession bear market happened in late 2011 in the chaos surrounding the fiscal standoff between Congress and the White House, resulting in the U.S. credit rating downgrade by Standard & Poor's. In that downdraft, large-cap stocks lost 19 percent before bottoming.
Nonrecession bear markets were also seen in 1998 and between 1976 and 1978. Both also featured a 19 percent decline on the blue-chip index. The 1987 pullback, which featured the Black Friday market crash and the Dow's largest percentage point loss, resulted in a total decline of 34 percent.
If we get a repeat of that, grab a barf bag now: That would put Dow more than 3,400 points lower than its current level.
Here are two points. First, bear markets don't necessarily need to be accompanied by economic contractions (although they tend to be tied together, with six of the last 10 bears featuring a recession). Second, these nonrecession bear markets can be quite painful.
Analysts at LPL Financial ascribe as much as 30 percent chance that we're heading into a bear market, and they recommend investors maintain "slightly above average cash levels for dry powder should the recent sell-off worsen." For a large conservative brokerage, that's about as panicked as it will get.
LPL pins that risk mainly on the chances of a mistake from overaggressive monetary policy tightening by the Federal Reserve -- which raised interest rates in December for the first time since 2006 and issued loose guidance that another four quarter-point hikes were coming in 2016.
The market has already delivered its verdict: That's a mistake.
Bond-market derived inflation expectations have collapsed. Commodity prices have plunged. Precious metals are on the rise partly on a safe haven bid and partly on the expectation the Fed will be forced to reverse course, potentially restarting its bond-buying stimulus. The futures market currently gives less than even odds of just a single rate hike this year.
Other risks flow from this: A financial crisis (a la 1998) possibly focused in currencies and a breakdown in market functioning (a la 1987). The good news is that LPL notes stock market valuations are reasonable and that equities are much cheaper than they were in 1987.
So take heart in this: Should a bear market come to fruition, the evidence suggests it will be of the milder variety.
