The Pandemic Stimulus Bill Has Expired and a Bear Market is Likely to Follow

Not long ago, it seemed that policy makers had figured out how to fix bear markets.

When financial assets were in free fall in early 2020, central banks and governments stepped in to orchestrate the fastest rally on record. For the S&P/TSX Composite Index, the pandemic-induced sell-off ended in just 22 trading days, compared with the post-war average of about a year it typically takes for bear markets to develop.

But the torrent of money creation, asset purchases, emergency spending programs and direct transfers to households came at a cost. And the bill is already due, at least for the stock market.

All that stimulus fueled runaway inflation and excess demand that must now be eliminated, setting the stage for a bear market more in line with historical precedent.

The market rally in 2020 “had a lot to do with the concept that central banks will always be there to save the day,” said Frances Donald, chief economist and strategist at Manulife Investment Management.

“This time around, central banks not only have no desire to intervene, but are likely to continue to squeeze that weakness.”

The stock market has yet to price in anything resembling a prolonged economic downturn, despite the bloodshed over the past two weeks of trading.

During that period, the sell-off in stocks accelerated dramatically, as investors faced the US Federal Reserve’s biggest rate hike since 1994 amid inflation that continues to run amok.

The S&P 500 Index is now down 23% from its January high, wiping out all of the index’s 2021 gains. The S&P/TSX Composite Index has held up better: its losses stand at 13% under the high price of raw materials. prices.

Investors naturally want to know the chances of the market bottoming soon. The problem is that the market decline to date has been driven almost entirely by a massive revaluation of share prices in the face of higher interest rates.

Corporate earnings estimates, on the other hand, have barely budged. And in a recession, S&P 500 earnings tend to fall by about 30 percent.

Already many companies are coming to the realization that they grew too aggressively trying to keep up with frenetic consumer demand during the course of the pandemic, said Bryden Teich, partner and portfolio manager at Avenue Investment Management.

Amazon.com Inc. AMZN-Qfor example, it recently said it has too much space and too many employees after doubling its fulfillment network and hiring 800,000 workers in the last two years.

“I think we’re in the early innings of a pretty significant belt-tightening by companies,” Teich said.

Across the corporate sector, costs are ballooning at the same time central banks vow to suppress consumer demand in the fight against rising prices.

“We are in a big storm here. I don’t see how earnings won’t collapse in the next six months unless central banks change course,” Teich said.

There is little chance of that happening. Last week, Fed Chairman Jerome Powell said he sees “no sign of a broader slowdown” in the economy, despite the sharp rise in interest rates and bond yields.

A few days before Mr. Powell’s comment, monthly US inflation figures beat expectations once again, with prices rising to a new 40-year high of 8.6 percent in May.

For its part, the Bank of Canada has promised to “act more forcefully if necessary”, after announcing three consecutive rate hikes.

That process could take some time for policymakers, after injecting much more stimulus than necessary during the pandemic.

“All of this inflation came from printing 20 to 30 percent more money than goods were available for sale,” said Michael Decter, chief executive of Toronto-based investment firm LDIC Inc.

“It’s Economics 101.”

His hope is that after a quarter or two, higher interest rates will slow the economy enough to control inflation.

“I would hate to see central banks overcorrect and crush the economy like they did in the early 1980s,” Decter said.

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