With the bull market now into its ninth year, a question that comes up a lot these days is how long it can continue. What will finally trigger the next bear market?
There are many catalysts that can set off a bear market, but one possibility is as prominent as the story that has dominated the news for the past few weeks – the damage done to East Texas, Florida and Puerto Rico by Hurricanes Harvey, Irma and Maria.
Now, to be clear, there is no equating financial consequences with the threat to human life and subsequent hardships that were caused by the recent hurricanes. However, when one considers the human toll taken by lost jobs and savings, the economic impacts are not trivial either, and are worth discussing. A look at the conditions that have led up to some significant bear markets in the past make it fair to consider whether the devastation caused by these hurricanes – and in particular their potential inflationary impact – might prove to be the catalyst that touches off the next bear market.
Market turns are not only tough to predict, but even as they occur they can be difficult to accurately spot until they are well underway. Harvey, Irma and Maria may or may not prove to be the catalyst of the next bear market, or that catalyst may turn out to be a dozen other things. However, a look at history shows that the one-two punch of the recent devastating hurricanes certainly has some of the characteristics of a bear market catalyst.
What causes the market to take a fall?
To understand how events like these hurricanes could eventually precipitate a decline in the stock market, it is instructive to look at some prominent down markets of the past 50 years:
Which brings us to the present day....
History doesn’t repeat itself in a precise fashion, so no two of these market declines are exactly alike. However, when reviewing the history of each one some common themes emerge.
Recessions are more likely to follow the start of bear markets. While people often link a bear market to weakness in the economy, note that recessions are more likely to follow the start of bear markets rather than the other way around. That plus the lag in time involved in identifying a recession makes economic growth alone a poor indicator of impending trouble in the stock market.
Bear markets are preceded by a falling dollar. Even though economic growth alone is a poor indicator of impending trouble,four out of the five bear markets summarized above were preceded by a falling dollar.Those same four bear markets were also preceded by a surge in oil prices. These same two factors, a weak dollar and rising oil prices, also tended to stoke the general rate of inflation in the run-up to these bear markets.
Major events have an affect. In many of the cases above some sort of shock – financial, political, or otherwise – acted as kind of a flashpoint to exacerbate concerns over economic conditions in general. Which brings us back to the recent hurricanes.
The extent of the recent storms’ damage certainly qualifies as the kind of shock that undermines public confidence. Beyond this shock value, the storms could have lingering economic effects. AccuWeather estimates the cost of the recent hurricanes will total $400 million. To put that in perspective, this is more than the estimated cost of the damage done by the 2005 hurricane season, which included Hurricanes Katrina and Rita.
In terms of a potential bear market catalyst, the biggest economic impact in the aftermath of this year’s storms may be higher inflation. Houston is a major petroleum processing center, and already retail gasoline prices are up 10 percent since mid-August. On top of that, Houston is a port city that serves as an important transportation link in the supply chains of many other industries as well. As for Florida, it produces 70 percent of the nation’s citrus fruit, including 90 percent of the country’s orange juice. Taken together, the damage from these storms puts inflationary pressure on energy and food prices.
Obviously, the inflation environment has been quite benign in recent years, but inflation is at its most disruptive when it seems to come out of nowhere. Its damaging effects are two-fold: price instability hampers business decision-making, and pushing interest rates higher tends to dampen economic activity.
As for the other recurring themes surrounding bear markets, it is noteworthy that unrelated to the impact from the recent hurricanes, the dollar has declined by 7.4% so far this year. That’s not too drastic a fall, but the trajectory is troubling.
Of course, not all disruptive shocks cause bear markets, and neither do all inflationary surges or dips in the dollar. So, recent conditions, including Hurricanes Harvey, Irma and Maria, will not necessary be the culprits behind the next bear market. However, those conditions do look a great deal like some of the usual suspects.