Get 40% Off
🤯 This Tech Portfolio is up 29% YTD! Join Now to Get April’s Top PicksGet The Picks – Just 99 USD

How Far Could Current Bear Market Go In Light Of Powell's Economic Projections?

Published 09/22/2022, 11:25 PM
Updated 07/09/2023, 06:31 PM
  • Powell expects Fed rates at 3.4% to 4.4% this year and 3.8% to 4.6% in 2023
  • With that projection, the Fed funds futures forward curve peaks right around May 2023
  • The average bear market for the S&P 500 lasts 16 months with a -35% drawdown

Jerome Powell's speech after yesterday's 75 bps interest rate hike announcement lasted only a few minutes but gave us a lot to think about.

First, the Chairman focused heavily on containing inflation, which must reach the 2% target according to him—a rather farfetched goal in the current scenario.

Then, he went on to provide some projections both on the employment and economic growth side of the U.S. economy between now and 2025, specifically:

  • Fed rates at 3.4% to 4.4% this year and 3.8% to 4.6% in 2023
  • Real GDP growth at +0.2% (from previous estimate of +1.7%) and 1.2% in 2023
  • Inflation: PCE expected at 5.4% this year, 2.8% in 2023, 2.3% in 2024
  • Unemployment rate at 3.8% this year, 4.4% in 2023 and 2024

Below, we can see the Fed funds futures forward curve based on Powell's projections:

Fed Funds Rate Forward Curve

Source: Chicago Mercantile Exchange

The projections anticipate the peak of the rate hike cycle around May 2023, so we can consider seven more months of stock market pain ahead of us. However, let's remember that the markets are an anticipatory indicator, so it is likely that we can start seeing a price recovery even before this peak.

Furthermore, Powell's speech sounded slightly optimistic for the first time in a while, implying that the "light at the end of the tunnel" could come before that (understood as the end of the rate hike cycle).

Market Reaction

While markets initially reacted very well to the speech—with gains of more than 1% for the S&P 500 and NASDAQ Composite—the current bearish mood eventually prevailed, driving major indexes deep into negative territory.

So what should we expect in the coming weeks/months?

I believe the investor should always reason by scenario analysis (positive and negative). Given that an adverse scenario remains the most likely amid the continuation of the tightening cycle, let's look at the length and magnitude of drawdowns of all previous recessionary periods and major stock market crises:Recession-Related S&P 500 Drawdowns

Consider that as of today, we have a year-to-date drawdown (using the S&P 500 index as reference) of around 20% that has lasted for nine months.

The worst drawdown in history occurred in 2008, with a 50% drop amid the Global Financial Crisis, but let's remember that the entire global financial system was on the verge of a collapse back then.

Apart from two exceptions in history—with declines above 40% and a duration of 20 to 23 months—the average scenario implies that a bear market drop should range between 30% to 40% and last 16 months.

Assuming that the current decline will last until the end of the Fed rate hike cycle, that brings us right around 16 months—if we consider January 3, 2022, as the start.

So, coming back to the present day, compiling Fed fund's projections with the average historical bear market drawdown, the most likely scenario would be a further 10%-15% drop in the S&P 500 over the course of the next seven months.

Will that scenario play out? No one knows. However, that is what I am preparing for by holding 13%-15% cash in my portfolio to be deployed bit by bit if the markets break below the mid-June lows.

Should those same lows represent the bottom of this bear market? All the better for everyone.

Disclosure: The author is long both on the S&P 500 and the NASDAQ Composite.

Latest comments

Risk Disclosure: Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.
© 2007-2024 - Fusion Media Limited. All Rights Reserved.