Liam Dann: Surviving a bear (market) attack

OPINION:

When confronted with a bear should we play dead ... or run?

Advice for those facing a bear in the wild is to back away slowly, if you have enough advance warning. If you end up in the jaws of the beast, then yes, play dead.

But never run. Apparently, you can't outrun a bear.

That seems like pretty good advice for investors in the face of this year's equity market mauling.

It's been a while since we've had to make those sorts of calls.

Most of us will have to stretch our minds back to 2008 and the Global Financial Crisis (GFC) to recall the sustained level of negative sentiment we're dealing with this year.

Earlier this month, the NZX50 followed global equity markets into bear territory — more than 20 per cent down from the most recent peak.

Technically, it was the second time they had hit that threshold since Covid impacted.

Markets crashed into bear territory in March 2020.

But that slump was so short-lived it failed to dent the bullish investor culture that had grown up on years of unrelenting growth.

In March 2020, trillions of dollars of central bank and government stimulus kept recession at bay during the uncertain early days of the pandemic.

The case can be made that the long post-GFC bull market really just kept rolling — albeit on life-support — until this month. This time the bear is different. This is a proper bear market of the variety we haven't seen since the dark days of the global financial crisis in 2008.

This is the one that will shift investor behaviour and leave a mark on the multitudes of young phone-app share traders that have come into the market in the past decade, never having dealt with a sustained downturn.

While no one likes seeing values head south, this rebalancing should present both a challenge and an opportunity for investors.

Clearly shares have been overvalued for some time. For many stocks — especially those in the tech sector — any tether to real-world earnings has long been broken.

There's almost no one within the financial sector that hasn't been expecting this rebalancing act.

The argument that we allowed a market bubble to form with loose monetary policy certainly predates the pandemic.

Opportunities to get interest rates back to more neutral territory were missed several times last decade.

Fear of deflation, recession and, perhaps, political repercussions, kept monetary policy in stimulatory territory between 2012 and 2020.

Now finally inflation has re-emerged and removed all policy discretion. Rates are on the rise, markets are correcting.

So, what should we expect from a proper cyclical bear market?

History tells us the process of rebalancing takes time.

Bloomberg data for the benchmark S&P 500 index suggests that the average length of a bear market (across the past century) is about 1.3 years with an average cumulative loss of 38 per cent.

The good news is that the average length of a bull market was 6.6 years with an average cumulative gain of 339 per cent. The numbers speak for themselves. The market rewards those who hang in there through the rough patches.

Of course, the factors driving the bull and the bear are always slightly different.

In 2008 it was the financial market meltdown led by a US property crash and the flow on to new and complex mortgage derivatives.

While its roots were also born in an extended period of easy credit, it ended with dramatic and relatively sudden seizing of credit markets and the financial system.

Though this crisis may yet come to a more dramatic crunch, it has arrived at a more measured pace.

We all watched inflation build in the wake of the pandemic stimulus.

We had time to debate whether it was structural or transitory.

With hindsight the stimulus was overdone as economic demand held up better than expected. The technology for communicating and working remotely was ready and waiting for us, the pandemic was the driver it needed. Businesses and consumers were able to keep the world trading from home.

The combination of stimulus and solid demand has maintained jobs and staved off economic meltdown but it also drove an asset price boom across everything from stocks and houses to Bitcoin and Nike sneakers.

The excess of cash might have been unwound more softly without threat of recession but events in Ukraine and China have conspired to lift energy cost and exacerbate already stretched supply chains.

The upshot of all that is that we face an uncertain outlook on inflation which will ensure market volatility for a while yet.

With little control over the supply side of the global economy, central banks have had no choice but to hike rates to curb local demand in their economies.

This bear market should be more of a controlled burn-off than 2008.

It is a deliberate act as central banks seek to remove demand from the economy rather than stimulate it.

In that sense it harks back to the financial cycles of last century, the inflation-beating era of the late 1980s and 1990s.

Local efforts to curb inflation have been hotly debated.

Was the New Zealand Reserve Bank (RBNZ) slow to pull back on stimulus, should the Government be curbing spending?

Whatever the validity to suggestions the RBNZ overstimulated, or was slow to remove that stimulus, it was more proactive that its international peers.

Relative to the Federal Reserve or Reserve Bank of Australia, the RBNZ has moved sooner and faster to hike rates.

The RBNZ started hiking last October and has hiked the official cash rate (OCR) from its historic low at 0.5 per cent to 2 per cent.

That has put us ahead of our international peers.

The big US Federal Reserve hike of 75 basis points took them to 1.75 per cent. Canada is at 1.5 per cent, the UK is at 1.25 per cent and Australia just 0.85 per cent.

Despite high inflation the European Union rate remains effectively zero and the Swiss, Danish and Japanese have maintained negative rates.

The pace of the RBNZ's OCR hikes and the start of quantitative tightening were adequate and "signalled a strong commitment to price stability", the Organisation for Economic Co-operation and Development (OECD) said in its most recent report on New Zealand.

Debate around our fiscal response to inflation will likely get more intense as we head towards next year's election.

The same OECD report last month made the case for more focused Government spending.

"Fiscal policy should avoid concentrating the burden of macroeconomic stabilisation on monetary policy, and support for households and businesses should be tightly targeted to those most vulnerable to high inflation."

However, the extent to which fiscal measures can do anything for short-term inflation pressure is hotly debated.

Nobody — at least neither major party — seems to be keen on a return to the policies of austerity which pushed unemployment to record levels in the 1990s.

While it will continue to rage, the local political debate has marginal influence over the broader direction of the NZX right now.

We are going to continue to be buffeted by a global storm for some time yet.

All eyes will remain on the Fed and how aggressively it plays catch-up on interest rates.

We're also at the mercy of historic geopolitical forces as war in Ukraine rolls on and China seeks to run its own course on Covid management.

If the world's energy prices and supply chains were to get a break, in either of those two areas, then it would relieve an enormous layer of inflation pressure.

We have the tools to fight domestic inflation, the only question is how aggressively we need to wield them and how much collateral damage there will be.

Interest rates are a blunt tool. Careful management of the economy will be required as they rise.

It's vital for example that efforts are made to assist property developers and construction companies through the crunch period.

The risk of recession is rising and slower

Over the next few months, the path (and the peak) for inflation and interest rates will become clearer.

Markets — always forward-looking — will price in the peak before it has fully worked its way through the economy.

But an economic slowdown or recession will also hit corporate earnings.

Earnings downgrades, as companies reassess their outlook for this period, will likely deliver a sting in the tail for investors.

Or perhaps that should be the crunch in the bear's bite.