Are we heading for a bear market in equities?

Equities are having a tough time. As of Friday’s close, the S&P 500 index is officially in correction territory, being down over 10% since the peak in July. But at least it’s up year-to-date. The FTSE 100 is down year-to-date, and the smaller cap FTSE 250 has lost 10% over that period. Not a good performance.

The theme that is causing the problem is monetary policy, with interest rates having risen further than the market had hoped and central banks telling us that they will stay higher for an extended period. So worried are the equity markets that good news in the form of stronger economic data has become bad news, as it raises fears of higher rates.

The shift in monetary policy, from being super easy to tight, is obviously bad news for risk assets in general. But I would argue that there are good reasons to remain confident that equities are not heading into bear market territory. Indeed, we should see evidence this week, that interest rates are not headed higher and we could well see evidence that they are set for big falls in 2024. Moreover, despite the evidence of slowing overall growth shown by the closely watched purchasing managers’ indices, we also see signs that corporate earnings growth is beginning to turn up, at least in the US.

Let’s start with the interest rate hurdle. Regular readers will be familiar with my argument that the tide has turned in the war against inflation. The US Federal Reserve’s preferred measure of wage inflation may well have been published by the time you see this. I expect it to show a further significant decline. The wage price spiral is operating nicely in reverse with lower inflation leading to lower wage rises. Later this week we get the critical data on jobs in the US. Yes, it’s likely that jobs will rise but labour supply is also on the up, led by immigration. Even if we don’t get an increase in unemployment in this week’s figures, the trend over the next few months is up and this will change the mood music within the Fed. And it’s not just the US, early indications are that core inflation is falling in Europe too.

So if interest rates are set to fall, what about the economic slowdown evident in the purchasing managers indices? The important point here is that services dominate overall economic activity, especially employment, but the earnings of quoted companies are much more sensitive to manufacturing.