Originally published by AMP Capital
Key points
The decline in shares could go even further, but a deep (grizzly) bear market is unlikely, because the recession in the US, the world or Australia is unlikely.
Increasing openness of the US Federal Reserve for a pause in raising interest rates, the likelihood of a trade agreement between the US and China in the next six months and the fall in oil prices reinforce the confidence that a grizzly bear market is unlikely.
Introduction
While global and Australian equities had a nice bounce after the lows in late October – about 5% rally, partly with a fall of about 10% from the lowest to the lowest, they have since fallen back to their lows as concerns about US interest rates, bond yields, trading, technical stocks, etc. have turned into wider concerns about global growth and profit. Fears of a credit crisis and falling house prices probably also do not contribute to the Australian equities, which were below their low in October this week. Our estimate remains that it is too early to say that we have seen the lows, but we remain of the opinion that this is not the beginning of an important bear market.
The three bears – correction, gummy and grizzly
Very simply there are 3 types of significant stock market declines:
corrections with decreases around 10% (of course these are not really bear markets – but some think they are!);
"Gummy" beets with declines of around 20% that comply with the technical definition, many apply to a bear market, but where a year after a fall of 20% the market rises (as in 1998 in the US, 2011 and 2015-16 for Australian and global equities); and
"Grizzly" bear markets where the traps are much deeper and usually live longer (such as in 1973-74, US and global stocks via the technical wreck or the GFC).
I can not claim the terms "gummy bear" and "grizzly bear" when I saw them first applied a few years ago by securities broker Credit Suisse (SIX :). But they are a good way to conceptualize them. Grizzly bears bring investors up and down, but gummy bears eventually leave a better taste (like the lollies). Corrections are very normal and healthy because they allow the sharemarket to blow off steam and not to overheat. As can be seen in the following chart, with the exception of the current delivery since 2012, there have been four corrections and one gummy bear market (2015-16) in global and Australian equities. Bear markets are generally less common, but perhaps we have seen a gummy bear market in 2015-16
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Source: Bloomberg, AMP Capital
The following table shows conventionally defined bear markets in Australian equities since 1900 – with a bear market falling by 20% that has not been fully reversed within 12 months. The first two columns show bear markets and the size of their traps. The third shows the percentage change in share prices 12 months after the initial decrease of 20%. The fourth column shows whether they are associated with a recession in the US, Australia or both.
Bear markets in Australian shares since 1900
Bear markets in Australian equities
Based on the All Ords, with the exception of 2015-16. I have defined a bear market as a decrease of 20% or more in shares that has not been fully reversed within 12 months. Source: Global Financial Data, Bloomberg, AMP Capital
If a gummy bear market is defined by a decrease of 20%, after which the market is higher 12 months later while the grizzly bear market continues to fall the rest of the subsequent 12 months after the first 20% decline, then its there have been 12 gummy bear markets since 1900 (these are marked in black) and there are six grizzly bear markets (highlighted in red). Several points stand out. Firstly, the gummy bear markets are usually a bit shorter and they see much smaller declines of 26% on average compared to 46% for the grizzly bear markets.
Secondly, the average rally in 12 months after the initial decline of 20% is 15% for the gummy bear markets, but it is a fall of 23% for the grizzly bear markets
Finally, and perhaps most importantly, the deeper grizzly bear markets are invariably associated with recession, while the milder gummy bear markets, including the 1987 market share crash, are usually not. Five of the six grizzly bear markets had an American or Australian recession or both, while less than half of the gummy bear markets saw a recession.
It is also true that US stock market falls are much deeper and longer when there is an American recession.
What is it probably this time?
Our position remains that a grizzly bear market is unlikely because, in the face of an unforeseen external shock, an American, global or Australian recession is not forthcoming. With regard to the US:
The confidence of companies and consumers is very high.
While the monetary conditions in the US have been tightened, they are not tight and they are still very easy worldwide and in Australia (with monetary tightening still a fair way in Europe, Japan and Australia). We are far removed from the kind of monetary tightening that leads to a recession.
Tax incentives continue to stimulate American growth.
We have not seen the excesses – in terms of debt growth, over-investment, capacity problems and inflation – which normally precede recessions in the US, worldwide or Australia.
As a result, global earnings growth is likely to remain reasonable – although slower than it has been – and provide underlying support for equities. With regard to Australia – yes, house prices are falling and this will have a negative impact on consumer spending, but it will be compensated by a decline in mining investment, reinforcement of non-mining investments, booming infrastructure expenditures and solid growth in export earnings. It is unlikely that growth will be as strong as assumed by the RBA, but it is unlikely that it will end up in recession
For all these reasons it is unlikely that the current fall in shares is the beginning of a grizzly bear market. However, we have already had a correction in common shares and Australian equities (with a decline of around 10%) and with falling markets it could become a sticky bear market, where the markets are 10% lower – many technical problems the damage was caused by the fall of October that made investors nervous, the recovery of late October was not particularly convincing and many of the driving forces behind the fall of October have not yet been resolved.
Positives
There are, however, three developments that contribute to our belief that we are not going into a grizzly beer market. Firstly, recent comments by Fed Chairman Powell and Vice-President Clarida indicate that the Fed remains optimistic about the US economy and that an increase in December appears to be secured (for the time being), but is aware of the risks for the US growth as a result of declining global growth, the declining fiscal situation. stimulus next year, the delayed impact of eight rate hikes and stock market volatility and it seems possible to slow the rate of interest rate hikes or pause somewhere at a particular time next year. The stabilization of core inflation around 2% that has been seen lately can support this. Previous sticky bear markets (1987, 1998, 2011, 2015-16) all saw some rest or relaxation by the Fed.
Secondly, although it is messy after the US / China impasse on the recent APEC forum, there are some positive signs about trade. Trade talks between the US and China have reportedly resumed prior to a meeting between President Trump and President Xi at the G20 summit next week and President Trump reiterated his optimism about a trade agreement with China and that the US may continue rate rises on China are put on hold when there is progress. The trade dispute between the US and China is unlikely to be resolved quickly when Trump and Xi meet. Perhaps the best thing that can be hoped for is agreement to conduct formal trade negotiations with the aim of solving the problems and agreeing to delay further tariff increases. Now that Trump wants to be re-elected, I continue to believe that a deal will be concluded before the tariffs cause too much damage to the US economy. Increasing unemployment (as the fiscal stimulus will decrease next year as the current and proposed rates / taxes on China continue) and higher prices at Walmart (NYSE 🙂 will reduce Trump's re-election prospects by 2020. Of course, investors are now very skeptical about any progress on the trading front. So any breakthrough in the next six months could have a big positive effect.
Finally, although the 30% dip in the oil price since the October summit is negative in the short term for equity markets through energy producers, it has the potential to expand the economic cycle, such as the fall in the oil price 2014-2016 did. The main causes of the decline in oil prices are slower global growth in demand, the US is abandoning Iranian sanctions, allowing several countries to continue importing Iranian oil, US stocks rising, the US $ rising and long oil positions cut off. Although oil prices are unlikely to fall as much as in 2014-16 when they fell by 75% (because the OPEC reserve capacity is now smaller), they may be able to remain low for longer. This is bad for energy companies, but perhaps not as bad for shale manufacturers as in 2015, because they now have less debt and their break-even oil price has already been reduced to $ 50 / barrel or less. It will depress overall inflation (monthly inflation in the US can be zero in November and December) and if oil stays long enough, the underlying inflation can be dampened. All this can keep interest rates low for longer. And the good news for motorists who see increasing purchasing power. For example, Australian petrol prices dropped from more than $ 1.60 per liter a few weeks ago to below $ 1.30 in some cities. That is a saving in the average weekly household consumption of about $ 10.
Turnout then declines in weekly gasoline coverage for a typical household
Source: Bloomberg, MotorMouth, AMP Capital
