The Bear Market is here. What Now?

June 15, 2022 – With the recent confirmation of a Bear Market finally taking hold, I’ve gotten some requests to comment on the situation: Are we going to have a recession? What’s my inflation outlook? What to expect from the Federal Reserve? What does this all mean for us in the FIRE community?

Let’s take a look…

Just to be sure, the Bear Market started in January, not on June 13!

I made this point in a post two years ago pointing out the challenges of pinning down the stock market (and also economic) turning points: If we define a bear market as a drop of 20+% then the bear market is confirmed once we hit the 20% drawdown. But the bear market started on the day after the previous all-time high. So, we’ve been in a down market since January 4, when the S&P 500 dropped from its all-time high. By only 3 points to 4,793.54. We just didn’t know it back then. Sometimes ignorance is bliss! Why is this important? It’s good news, of sorts, because if go by the average length of bear markets of maybe 1.5-2 years, we’ve already lived through about 5.5 months of it. Yay!

Of course, I always like to issue the warning that the length of the bear market is meaningless. What matters is how long it takes for the market to recover and reach the next all-time high again, which could take many more years. And when adjusting the portfolio for inflation the recovery can sometimes take a decade or more, as I outlined in my old post “Who’s Afraid of a Bear Market?” in 2019.

Will we have a recession as well?

Not every bear market is accompanied by a recession. All of the prominent ones were, but we’ve had a few without a recession, for example in 1987. And a few “close calls” like the fourth quarter of 2018.

In any case, what’s the economic outlook? Am I worried about a recession? I’m no longer a full-time economist. Even the short consulting gig as a “Chief Economist” for a startup only lasted for only a year in 2021. So, not willing to run a big forecasting model, which is at least a part-time maybe even a full-time job, I like to keep things simple. As I introduced in a 2018 post, here are the three indicators that I like to follow as a hobby-economists to monitor the health of the economy and the prospect of an economic slowdown:

1: The slope of the yield curve is one of the most reliable recession indicators. At some point before the start of the recession, all those smart folks working as fixed-income traders apparently sense that the Federal Reserve will first yank up rates and then lower rates again 1-2 years down the road, in response to the slowdown. This will push short-term rates higher and long-term rates lower. And apparently, those fixed-income folks were so smart that they even predicted the 2020 pandemic recession with a very brief yield curve inversion in August 2019. Some of them must be virologists, who knew?! Joking aside, financial markets probably didn’t have any inside knowledge and even without the pandemic, there might have been an economic slowdown around the corner.

In any case, that yield curve signal again flashed (slightly) red in early April of 2022. It’s a slightly worrisome signal, but the brief and very shallow YC inversion isn’t that concerning. For example, in 1998 we had a similarly meek inversion and the recession took another 3 years to take hold.

The 10-2 yield curve slope (in basis points=0.01%). Marked in red are when the yield curve inverted, i.e., the 10Y yield dropped below the 2Y yield. (2Y-yield was not available before 1976, so this is spliced with the 10Y-1Y spread before).

2: Weekly Unemployment Claims have been a pretty neat signal in the past. Every past recession was preceded by a sharp rise in the weekly unemployment insurance claims. Even though the NBER business cycle timing committee uses the monthly payroll employment numbers in determining the business cycle turning points, I like this series better because it’s at a higher frequency and doesn’t have to deal with those pesky benchmark revisions like the payroll series. In any case, according to this series, we’re still looking great. Unemployment claims are close to their post-pandemic lows, around 200k. Neither level nor direction indicates an imminent recession risk.

Unemployment claims (in 1,000s). Claims normally rise even before the start of the recession!

3: The Purchasing Managers Index (PMI) is another important economic health indicator. During or even before recessions, we’d normally observe a marked fall in the PMI index, usually below 45. Of course, anything below 50 is already looking shaky. In fact, the level of 50 is the +/-0 line between contraction and expansion, but there have been a few “false alarms” when the PMI fell to a level between 45 and 50. Below 45 seems to be a clear sign of the economy doing poorly. Right now, we’re still above 55. In fact, in May the PMI even edged up slightly to 56.1 from 55.4 in April. While the PMI readings have certainly come down from their 60+ levels in the Spring of 2021, we’re still looking pretty solid. No recession warning signals are flashing red here!

PMI Index: There have been plenty of occasions where the index temporarily dropped below 50 without a recession following. But a drop below 45 is a pretty good recession indicator.

So, with my recession indicators, we’re 1 for 3. Hey, maybe only 0.5 for 3, if we factor in how brief and shallow the YC inversion was. So, the economy still seems to chug along. Everybody should be happy about that, right? Right? Uhm, maybe not. You see, in a perfect world, the Federal Reserve will slowly tighten the policy rate to about 4% by next year, inflation pressures will slowly abate, and we avoid a recession as well. The perfect soft landing. In a blog post five months ago, that was my personal prediction. While I still hope for this scenario, I’m almost sure that the path of the economy will be bumpier. The big gorilla in the room: Inflation! Notably, there are two unpleasant observations:

1: Inflation doesn’t seem to go down on its own. Thankfully, we’ve now retired the “transitory” moniker. The year-on-year CPI just posted a 40-year high. How is that possible? True, we’re now phasing out the strong inflation readings from the Spring of 2021. But we’re now replacing them with even worse monthly CPI numbers. And thus, the nasty CPI surprise on June 10 set off the whole equity selloff.

And the June 2022 CPI reading (released on July 13) will probably be another bummer, looking at the energy price surge in June month-to-date. What’s worse, it’s not just food and energy prices. A slow-moving train wreck is coming our way, in the form of shelter (i.e., rental) inflation, both for actual rental units but also for owner-equivalent rent (essentially derived by extrapolating the market rent to the owner-occupied market). Rental inflation factors in rises in real estate prices as well as interest rates but with a delay. In the chart below, notice how the shelter CPI trough lagged the overall CPI trough by about a year. In other words, rental inflation stayed relatively benign during the early part of the inflation shock. But the rental inflation train is now gathering steam. Housing is the largest component of the Core-CPI! A quick decline in year-on-year CPI numbers is certainly off the table. And we might even see further acceleration. Buckle up, everyone!

CPI YoY readings. Source:, St. Louis Fed FRED database. Note: there is also an overall shelter category, which includes other shelter costs, incl. energy. The shelter series I plot here is just the pure rent category: “Consumer Price Index for All Urban Consumers: Rent of Shelter in U.S. City Average”,

2: Contrary to the public’s perception, U.S. monetary policy isn’t tight at all. Quite the opposite, the Federal Reserve effectively continues to pour gasoline on the inflation fire. How is that possible? Isn’t the Fed raising rates already? 75bps at the meeting today, on June 15! That sounds like monetary tightening, right?

Well not really. What matters for real economic outcomes is the real, inflation-adjusted policy rate. Right now, that real FFR is still close to its all-time low. Consequently, in response to a worsening inflation shock, our current monetary policy is actually more accommodative than at the bottom of either the Global Financial Crisis or the Pandemic Crash when the central bank accommodated with a real FFR in the -3% to -1% range. In other words, the real FFR is now lower than when everyone ran around with their hair on fire, worried about deflation. The Fed raised the real FFR to around 3% above trailing inflation during the 2000 and pre-GFC tightening cycles. Even in 2018, we at least reached a (slightly) positive real short-term rate.

Fed policy, measured as FFR minus trailing CPI. We’re still more accommodative than during the depth of the past two recessions.

Let’s face it, we won’t see any true monetary tightening until short-term rates exceed the inflation rate! By that measure, the Fed is about 6-7 percentage points behind the curve. It would take many more rate hikes to correct that. Ouch!

How did this happen? Very simple, my former colleagues at the Federal Reserve apparently forgot about a very simple monetary economics doctrine: the Taylor Principle, named after famed Stanford economics professor John Taylor. I would summarize the principle as follows:

Taylor Principle: The central bank should move the nominal policy interest rate by more than one-for-one in relation to inflation shocks. This produces a tightening effect in the form of a real interest rate hike, slowing down demand and reducing inflation pressures.

But I don’t want to ding the Fed too badly. It was easy to get complacent. During the entire post-GFC era, even the post-2001 era, economists were puzzled that despite massive and prolonged monetary and fiscal stimulus, inflation didn’t rise much. What a conundrum! It was easy to forget basic economic lessons.

The image that comes to my mind is that of someone trying to start a BBQ, pouring copious amounts of lighter fluid on the grill. The thing still doesn’t start. Let’s empty another bottle! We need more stimulus! And then it does start and almost sets the whole neighborhood on fire. That person with the singed hair and eyebrows: that’s how the Federal Reserve is feeling now.

What would be the easy way out of this mess? A mild recession right around the corner could be a blessing in disguise! It would likely break the self-fulfilling prophecy inflation spiral. It would take pressure off of energy prices. New and used car prices could return to normal levels. You might be able able to get a rental car again at reasonable prices! That’s because during recessions, even mild recessions, consumers like to tighten their belts. Spending less on durable goods and discretionary items always does the trick.

If we don’t have that marked slowdown soon and prices don’t come down on their own? Expect rate hikes at 50-75bps every meeting. At least we don’t get a 200bps hike in one meeting, as proposed by Jeffery Gundlach! Either way, the Fed will raise rates until inflation subsides. In all likelihood, that will eventually trigger a recession if the Fed has to go into a full Paul-Volcker mode.

Again, I don’t want to sound like a doomsday preacher. I certainly prefer the scenario where we can thread the needle and everything still works out all right. But absent that optimistic scenario, I prefer the near-term mild recession. Let’s just get it over with! Let Paul Volcker rest!

Conclusions: What does this all mean for the FIRE community?

The usual disclaimers apply: it depends on where you are on your FIRE journey. If you’re still years away from (early) retirement, you probably should not stress out over this. Automate your savings and investments. There is no point in trying to time the market. Remember the old advice “time in the market is more important than timing the market.” My retirement plan contributions during 2001-2003 and then again in 2007-2009 were some of the best investments I ever made, thanks to dollar-cost-averaging. This bear market will turn around again. In fact, following a painful inflation episode and the Fed sinking the economy in 1982, we had one of the longest and most robust equity bull markets. Stay the course, everyone!

If you are close to retirement or even in retirement, you have more reasons to worry. Going through a bear market is more damaging to your finances when you are taking withdrawals already. It’s called Sequence Risk and I have written about it extensively. Readers of my blog and my Safe Withdrawal Rate Series will likely start with a conservative enough withdrawal strategy that would have withstood even the Great Depression. A 20% drop in the stock market is nothing compared to that. Also, check out Part 37 of the SWR Series, with my recommendations during the 2020 bear market. For example…

After we’ve already fallen by 20+% we can be a lot more generous with our safe withdrawal rates. Historically, you can use withdrawal rates well in excess of 4% if the stock market is down as much as today!

SWR Series, Part 37.

Yup, you’ve heard it here first: The 4% Rule probably works again in today’s environment, after the market dropped by 20%+!

Another question I frequently get: Now that the stock market is down, should retirees shift to 100% equities again? If the bear market stays relatively shallow and rebounds quickly you might look really smart. But again, in Part 37 of the series, I point out that during the really catastrophic equity bear markets, going all-in too soon would have backfired spectacularly.

Update 6/15/2022, 6PM:

Since someone asked: with the recent drop in the S&P index, how does the valuation look like now:

  • With the 6/15 close of 3789.99, my CAPE now stands at 28.6. We can’t use the Shiller numbers because the index and earnings data are outdated. That CAPE is still 80% higher than the historical median.
  • I also compute an adjusted CAPE that accounts for different corporate taxes and earnings payout ratios. The adjustment lowers the CAPE to 22.9. Still elevated but not that bad. 45% higher than the median.
  • PE ratio using 12-month trailing earnings: 18.9. Only 27% higher than the historical median.
  • PE ratio using 12-month forward earnings estimates: 17.2. 20% higher than the historical median.

So much for today! Stay invested, stay safe and enjoy the ride, everyone! Looking forward to your comments and suggestions!

Title picture source:

110 thoughts on “The Bear Market is here. What Now?

  1. “If you are close to retirement or even in retirement, you have more reasons to worry.”

    Gee, thanks Big ERN. Wink. Great post, love your analytical approach during these interesting times. Also, I should add that having my 3 years in cash in Bucket 1 is reassuring during these volatile times. I know we disagree on the Bucket Strategy approach, but it’s during times like these that I’m pleased I implemented that approach in my retirement. Sure, I give up some opportunity cost, but it’s worth it to avoid the SOR risk in my humble opinion. Keep up the great work!

    1. Hah! The never-ending discussion!
      I think for about 2/3 of this we’re in complete agreement. The cash bucket can be modeled in 3 ways:
      1: static weights with regular rebalancing. We’re just back to a portfolio with about 60-80% stocks and the rest in lower-risk diversifying assets. True, withdrawals come out of the cash bucket. But the cash bucket is regularly replenished from the risky asset, this is mostly window-dressing.
      2: A glidepath. You slowly shift out of the low-risk assets and more into risky assets. Without any tactical timing. Makes sense. Kitces and Pfau showed that this partially hedges against Sequence Risk. I confirmed that with my toolkit.
      3: Tactical asset allocation between stocks and cash. I used to do this for a living at BNY Mellon Asset Management. It’s a very difficult task. Timing the equity premium is the holy grail of all active asset management. More difficult than stock picking. No retail investor will do this right consistently. It will be mostly a “hit or miss” kind of deal. Every experienced market-timer will tell you that especially valuation-based signals (i.e., “I will just time my equity vs. cash withdrawals based on how cheap/expensive equities are”) will not help you in this short-term tactical asset allocation problem. Also, even if you could eke out a small market timing alpha, the fact that you do this timing strategy with only a small portion of the portfolio means that you maybe add a few 0.01% extra expected return to the overall portfolio. Not a viable strategy to materially improve retirement safety.

      We probably agree on 1+2. Not sure if we do on #3.
      Thanks for stopping by! Hope all is well, Fritz!

  2. I FIRE’d this past fall in my early 40s. After reading your (ERN) post about equity glidepaths and Kitces Bond Tent posts/articles I decided it was prudent to do so. I still would rather not deal with the poor sequence risk, but glad to have a plan.

    6-8yr glidepath, inital AA 75/30 targeting 90/10, FIRE date WDR of about 1.5% and current WDR of about 2%


  3. > Let’s face it, we won’t see any true monetary tightening until short-term rates exceed the inflation rate! By that measure, the Fed is about 6-7 percentage points behind the curve. It would take many more rate hikes to correct that. Ouch!

    Yes, but: Of course the fed’s actions affect the inflation rate, so they are not isolated variables. Sometimes fed can move the rates just by *implying* they will take some action. This is what they thought they were doing all through this. But it is a psychology game, sometimes people think that (other people think) the fed will have an effect, and so behave as if it is real, and other times they doubt, and don’t.

    I know you know this, but just pointing out that the fed will not (I hope) have to rase rates by 6% to make people think they are serious, at some point before that, people will get it, and inflation will start coming down.

    1. The Fed’s inaction has moved the real interest rate so low that we generate more stimulus.
      We can certainly hope that the Fed still has reputation left and things will turn. The last time they tried this “wishful thinking” was the 1970s. Didn’t work so well.

  4. As recently FIREd person, this is the monster in the closet that we all fear in the early years. Do I feel better having paid off my house? Yes. My core expenses are lower as a result, and I align with Kitces’ thoughts on variable spending with “core” plus “adaptive” expenses.

    My portfolio is 80/20 – although who knows how far out of alignment that’s become in the last couple months; do I rebalance?

    It’s the inflation that worries me…

    1. Inflation worries hit both stocks and bonds in the short-term. Long-term equities are better off.
      Have you considered TIPS?

      Your case also highlights the importance of automating the rebalancing. If you let the weights wander off too far, you’re now getting into the business of market timing because you stress out over when exactly is the best time to to do a large rebalance.

  5. What’s the CAPE looking like? Prices are down but earnings are still going up. How far are we from saner valuations? Might we be able to bump the SWR back up to 4%?

      1. Looks like Shiller has updated his numbers for June. I have the last several-few months (technical descriptor there) CAPE from his yale-edu website as:
        2021.12 – 38.3
        2022.01 – 36.94
        2022.02 – 35.29
        2022.03 – 34.27
        2022.04 – 33.89
        2022.05 – 30.8
        2022.06 – 28.7

        Huzzah on being firmly in that 20-30 range! Honestly, as a person contemplating retirement in about 1-2 years I’m crossing my fingers that I hit a March-2009-esque lottery there.

        1. Haha, March 2009 would be a bit low. But we’ve moved significantly below 30, and 12-month forward PE ratios are now below 17. Seems like a pretty decent equity valuation. We don’t need to fall to a 2009-level CAPE again! 🙂

            1. Awesome, yea I usually just drive straight to his excel file there then export as a csv. I’m more likely to use that in R / Python, etc rather than working within excel. I get annoyed with his formatting… in particular having like 9 rows at the top for the column headings.

              Anyway, with respect to the data there, he has updated CAPE ratios but hasn’t completely filled in all inputs (in particular real earnings). It makes it difficult to see what inputs are pushing CAPE ratio one way or the other. (Therefore ERN’s upcoming proposed CAPE post will be an interesting read).

      2. Quick question: do you have a post anywhere with your alternate CAPE processing as far as what inputs or calculations are involved?

        Thank you.

      3. Where are you getting your numbers for forward PE and historical average? I have a forward S&P500 EPS estimate of 239 (from Yardeni but all sources seem to be 225-240), with the index currently at 3675 the PE is ~15.3, which is actually quite a bit below the historical average from 1990-2015 (can’t find older data than and the last 7 years have probably dragged that average up a bit. I honestly wouldn’t be shocked if a 6% SWR ended up surviving from here even though I wouldn’t recommend it.

      4. Where are you getting your numbers for forward PE and historical average? I have the forward EPS estimate for the S&P500 at 239 from which puts us at a forward PE of 15.3 with the index at 3675. The most historical data I can find is from 1990-2015 from where the historical forward PE averages 16.5 and the last 7 years probably dragged that average up some more. So at least on forward PE we’re quite a bit below historical average valuations, in a place similar to 1991 or 2003, and though I wouldn’t recommend it, I also wouldn’t be shocked if a withdrawal rate of 6% from this point turns out to survive with flying colors.

  6. Thanks a lot for this post – was really looking forward to hear your “science”-based voice accross all that messy noise … One question nevertheless: You are advising against 100% equity for retirees, which seems very common sense (and when playing around with your spread-sheet I also came to the conclusion that 70-80% would be optimal as a static allocation). However, in one of your posts about the glidepath (, you are showing that 100% equity allocations (after 10-15 y of “gliding”) outperform the 80% equity endpoints. Should a retiree whose portfolio has reached eg. 100% equity following a glidepath now sell equity to rebalance back to 80% or rather maintain the 100%? Should those who are are just about 80% or 90% stop increasing?

    1. If you retired ~10 years ago, your portfolio has probably skyrocketed! So you’re unlikely to be in trouble either way.

      1. Unfortunately I (was) retired in November 21 and was planning a 60-100% equity glidepath (active), so wondering whether to actually implement it at my first rebalancing in July. For the moment the amounts are not that huge, but I am the kind of person who always needs to see the whole picture, understand the principles and know how things are supposed to work. Thanks for your encouragement nevertheless.

    2. The glidepath is a hedge against the worst case scenario when the portfolio goes down significantly after 10 years. At that time you would have been better off in historical simulations to roll the dice and bet on an equity bull market.
      I don’t recommend going 100% equities if the market is at an all-time-high or close to it.

      Of course, you could also get lucky and nothing happens to the portfolio during the first 10 years. In that case you can still play it safe and keep the equity portion well below 100%.

      1. To sum it up: You are recommending rather the “active” than the “passive” management of the glidepath (as specified in part 19: “Active means that we increase the equity share only when equities are “underwater,” i.e. when the S&P500 index is below its all-time high”.)
        According to your chart:, the lowest failure rates occur with 100% equity targets – the optimum being 60-100% “active” with 0.4% monthly increments. That’s why I am about to set myself on such a PATH … (adjusting twice a year on fixed days), but certainly not 100% equity NOW ;-).
        On the other hand, for an 80% equity target the best monthly increment would be 0.3%. This is not that much of a difference at a time, but consistency being king, I prefer to get it right from the start.

          1. Karsten, others also being interested in glidepaths under current market conditions (as it seems), would you perhaps like to make an update to your 2017 publications on the subject? In my understanding, the opportunity costs of the “bond-tent” (or whatever low volatility assets it may contain) should be increasing currently, in regards to equity.
            How would eg., look like with the following hypotheses -unless you consider these to be totally absurd: 1) Nominal equity returns growing in correlation to a “high” inflation rate 2) Nominal returns of low volatility liquid assets staying “below” that inflation rate. (Leaving a realistic quantification of these hypotheses to the expert).

      2. Karsten, you are hitting on an interesting topic here, worth writing a post about: what is an optimal allocation glidepath, assuming the first 10 years went well, or the first 20 years went well (probably does not make much sense to go much beyond that even for a 60-year retirement)? Of course, if the first 10-20 years go well, one can also reset his/her withdrawal amount. This could make for an optimistic post which people in the FIRE community like so much 😅

        1. If your first 10 years went well, you might want to “re-retire” and reset everything back to a higher bond allocation and roll down the bond share from there.
          I could write a new blog post about that. Yes, good reminder! 🙂

  7. SWR of 4%+ again is the only good news lately. But FED balance sheet is still sitting at 9T. I wonder what will happen they they start selling all those assets. Won’t the bond market tank along with stocks? I don’t see the bottom of this anywhere close yet. Do you ?

    1. If we can thread the needle and inflation comes down quickly the market will rally again. I don’t think that’s impossible.
      Even the possibility of a small recession (comparable to 1991) wouldn’t mean that stocks have to fall much more.

  8. What about the bond portion of a portfolio? The “chatter” seems to say that it is easy to time the bond market (ie. move to cash now and back to bonds when the rates stop rising), but the chatter was wrong for so many years leading up to this point. Do you address what to do with the bond portion in a rising rate environment in any of you many installments? Any analysis to share?

    1. Bonds are in a negative momentum move. Cash/short-term is certainly better right now. I’d get out of anything nominal, fixed interest rate and move to either TIPS or floating rate bonds.

      1. I remember reading an article about how a 75/25 stocks cash produced very similar results to a 60/40 with slightly more volatility.

  9. “The 4% Rule probably works again in today’s environment, after the market dropped by 20%+!”

    The current drop in the S&P 500 brings it back to the level that it was around December 2020. Would it have been prudent to plan on a 4% withdrawal rate in December 2020?

  10. “The 4% Rule probably works again in today’s environment, after the market dropped by 20%+!”

    The current drop in the S&P 500 brings it back to the level that it was around December 2020. Would it have been prudent to plan on a 4% withdrawal rate in December 2020?

    1. BE: Have you published your actual portfolio at some point? That would be a fascinating long read.

  11. “… my CAPE now stands at 28.6. We can’t use the Shiller numbers because the index and earnings data are outdated.”

    How can someone find accurate CAPE numbers?

    Haha – an article on CAPE would be very helpful for many of us. Thanks!

    1. Well, an easy way would be to use his last S&P estimate and rescale everything to today’s S&P.
      That would take care of most of the Shiller error.
      Factoring in newer earnings estimates might be too much work for the average investor. Wouldn’t make too much of a difference either!

  12. Love this article!

    A great breakdown of the current situation, and while it stinks to be in a bear market I feel that I’ve planned as best I can for this. I have a small cash bucket (I know, I know), that will last another year – AND I’ve also picked up a cash flowing web property that is now covering about 30-40% of our expenses. It feels like I had to un-retire for a bit, but if I can get the website to cover 50-60%, then I can fully retire again knowing I’ve squelched the sequence of return risk and the recession risk.

    We shall see!

  13. Hi Big ERN, do you have any thoughts on this strategy I am using:
    DCA purchasing on long term US Gov STRIPS (EDV, duration =24 years) as the price drops on subsequent Fed actions (on Fed Rate and Quantitative Tightening which is starting in June), and then when the (mild) recession comes and the Fed forces rates back down to counter the recession, then EDV will shoot back up and I will sell using DCA.
    I have this money right now in cash (money market). I am following a Glide path now at 75% equity and 25% in Money Market (sold bonds in Jan 2023). 2% withdrawal rate as I am targeting to leave a legacy to our children . Our ages 75 now.
    Always enjoy reading your articles, truly clear, educational, and useful.

    1. I always caution against strategies that work out in the end and might awful along the way.
      If you do this without leverage you might be OK. With leverage this can be very dangerous.
      Check how your P&L will look along the way if the 20-30-year bond yields go all the way to 8-10% (my worst-case scenario). If you can sustain that and bet on the 10Y yield to go back below 3% again long-term, then more power to you! 🙂

  14. Greetings from the other side of the pond. Recent events are a reminder to everyone why (a) buying stocks on margin (b) extrapolating the past into the future is never a good idea.

    I am struck by some commentators expressing how negative asset price performance is. And yet the S&P 500 is really still at pretty elevated levels. My sense is that this bear market has some way to run with interest rates proving an heavy downward weight on valuations.

    Still at least you are the right side of the pond. Over here in the UK, we are in significantly more economic trouble with even less levers to pull than the US. Economic growth is well below that of the US over the last decade and Brexit is exacerbating our negative performance. No recognition amongst the population of the issues we face and a not insignificant number of people are going to have to choose between heating or eating this winter.

    In the same way that the good days don’t always continue, neither do the bad days. At some point in the future, the Ukraine crisis will abate (even the 2nd world war only lasted roughly five years and this isn’t that one would think), inflation will surprise on the downside, earnings will continue to move forward and that will be the seeds for the next bull market. Could be one, five or ten years away. Who knows.

    1. Vietnam lasted 10 years. Although on the bright side the 100 years war didn’t last 100.

    2. Everyone in Europe hopes that the Ukraine war is resolved before the winter. Otherwise, there might be some real hardship in Europe. Not good going through the winter with 50% less Nat Gas.

      As I wrote elsewhere, in the case of a mild recession, it doesn’t look like the S&P needs to fall much more. Maybe another 10%? Not the end of the world.
      Now, if the Fed needs to raise rates to 10%+, that would be a different story. But I hope we can avoid that.

  15. Hey Big ERN. I calculated the one year return (and the corresponding percentile from the historical data in your spreadsheet) and came up with the following:

    SPX = -12.7% (9 percentile)
    IEF = -14.8% (0 percentile, worst)
    60/40 Portfolio = -13.5% (3 percentile)
    Real 60/40 Portfolio = -22.1% (2 percentile) Ouch!

    The YTD (6 month) is even worse, with the Real 60/40 around -23.1% (0.3 percentile)! The poor bond (IEF) returns and high inflation are really bringing the real returns down. It seems like bonds and stocks have been strongly correlated during this bear market. Do you have any thoughts on when the negative correlation (or at least uncorrelated nature) will return?

      1. Would have worked better in 2022. Not so well in 2008/9. Every recession is different!
        Ging forward, given the large Fed uncertainty, I’d certainly prefer the S&P/TIPS over S&P/nominal bonds!

  16. Random question here; I’m close to retirement (3-5 years) – I want to buy some long term bonds in my ROTH IRA’s and short term or total market bonds in my taxable brokerage. I get hung up on the following guidelines.

    Stock Market goes up, bonds go down
    Stock Market goes down, bonds go up
    Interest Rates go up, bonds go down

    I have zero bonds now – and want to start using my W2 money to build 10-20% bond holding – – –

    When should I start? or when is it safe to start this process?

    1. I should specify, I’m not “stopping” buying index type funds, those are in my 401k @ just under 1k/mo. So I will continue to DCA equities through the bear market… I will switch from tax deferred contributions to ROTH contributions in my 401k though, I have enough deferred.

      The other option is to continue DCA 100% equities through this period, then after retirement, maybe sell some equities to buy bonds within a tax advantaged account…

      Steve (NWOutlier)…
      PS – just looking for opinions, I understand that we all do not give financial advice 🙂

      1. Thank you! Interesting; I keep a small handful of “Great Articles” saved in favorites in my browser. VERY few get in there; seems I have saved this exact part (part 43). I will re-read and get a grasp! thanks again!

        Steve (NWOutlier)

  17. This whole thing is messed up. The idea is that inflation didn’t go down – by March 2022 – so we need to crash the economy and crush investments.

    To me, it seems like the Fed should have been far more patient. How about wait until some of the issues that cause the inflation – mainly supply chains issues due to COVID past and present, have been resolved. Then give it 6 months.

    The down side is 8% inflation for a couple more years? Who really cares. I’d rather pay that on groceries, but have my money back. Stuff like new cars are not really going up much (like %500 on a 65k car). But the dealers try to sell over MSRP. A suplpe issues.

    My big picture vote is to go back in time and skip the last 3 tax cuts so the national debt isn’t so high. Contra-cyclical.

    1. The fed has been fairly dovish in light of the sudden jump in inflation measures. ERN’s point is there isn’t really signs of an economic slowdown (looking at naive statistics, at least) so the fed has room to raise rates (and has really only just started pulling that lever).

      Further, if you’re looking for any persistent anti-correlation from equity returns to interest rates it doesn’t really exist. In fact, why wouldn’t stock returns go positive with higher interest rates?… that’s fed-confirmation the economy is strong enough to withstand the interest rate manipulation. Most companies have freedom to raise prices to offset inflation adjustment to costs and/or tightening of interest rates so there’s a lever of control companies have to stabilize their earnings and thus fundamental input to future equity valuations.

      To your point on supply-related shock to prices… without fed intervention why should prices come back down? Right now you have such high demand with limited supply across so many markets that prices have to rise. The vicious cycle is a company sees input prices rise and adjusts their prices upwards and so on and so on. But if demand is cooled because money is not as easy to come by this will shift the demand curve to the left and cause the equilibrium price to lower or at least stabilize (depending on demand elasticity within a given market). If a supply-side shock is the hypothesis behind current inflation then this also allows supply and inventory to be restored/replenished (separate discussion would be the implications the last year has had on the viability of Just-In-Time inventories).

      The trick is going to be not cooling demand so much that company revenues are hit extra hard and excessive unemployment results in a recession or worse. But this is far from an exact science.

      For 8% inflation… I mean that isn’t Argentina level inflation so yea… rookie numbers if we are having a worldwide contest but it still is concerning (some people’s personal rate of inflation will be much higher) and more to the point the rate of rise in CPI and PCE hasn’t been slowing… so intervention is warranted.

      1. I understand the theory. I’ve heard it many times. The Fed is 8 for 9 in starting a recession in these cases. There are so many unprecedented things going on though. So why can we hope this is the exception? Possibly because of the high job numbers.

        My point is – what is wrong with 8% inflation for a few years. After decades of low inflation. To your point, why with no intervention, why will inflation go down? Because the supply chains will be cleared up.

        In the car market, they are building cars with parts missing, then storing them in lots for weeks or months, then finishing them. Since there is little inventory at the dealers, people are paying over MSRP. Technically making the buyer poorer will reduce that demand, but we really need more cars in more price ranges. So the haves will still have in either case.

        The point of the stimulus was to avoid a deep recession – like after the 2008 disaster. So we did, but just pushed it off for a couple years. That stinks.

        1. Sorry I don’t mean to be patronizing… it’s so difficult to engage online since so many people end up with a diverse set of prior experiences and educations.

          I think if we could have 8% annual inflation with little to no other add-on negative effects then that would be fine. At some point this will become hyperinflation and there is little control over that situation. So yes, running headlong into a recession could be the lesser of two evils. A lot is made over Zimbabwe and the Weimar Republic but I think Argentina is a good case study as to some for the dangers of high inflation:

          And good paper on some economic views on inflation with some interaction with recession-economies:

          And I agree this does stink to an extent.

          1. “I think if we could have 8% annual inflation with little to no other add-on negative effects then that would be fine”

            Thanks for the links. Yes, hyperinflation is bad.

            I’m back to my initial concerns and thoughts. My gut says we just went off the rails. Two Friday’s ago inflation edged up YoY instead of edging down. The take away was a panic move by the Fed to go .75. I think that assures a deep recession. The options were to let the previous very aggressive rate hikes work though the system. They just started the hikes a few months ago.

            It makes sense YoY still went up – now we have a war. Plus a big Covid lockdown in China – so even worse supply chain issues. I’ve read on the tech side that engineers are down dumbing down next gen design to accommodate for not having parts available. That stinks,

            I listened to this podcast this weekend:


            I knew Powell was going to lean towards going light on increases. Now I see the history. Now I’m even more concerned with this pivot. In the engineering circles I hear about 1-3 years of supply chain issues.

            I think the old path of increases was already too aggressive. This makes it worse. I think Powell knows that, but was just pressured into it. If there was inflation without such clear causes, then OK. We know the reason. I feel bad for the guys that will get hit with layoffs. The ones that are just getting by now. Or the ones that are paying for kids collage. All as part of a plan? Ouch.

        2. It’s true that inflation has been low for a while. So, part of the inflation can be explained away by that. But we’re now wayyyyy above a 2% CPI path starting in 2008.
          This problem will not go away by itself.

    2. The Federal Reserve itself is the inflation shock. Pouring gasoline on the other factors like supply chains and Ukraine. Without any rise in the FFR the real inflation rate would be -8.6% instead of -7%. The Fed was patient for way too long. Should have started rate hikes in late 2020, at the very least in 2021.

  18. Hi Ern

    Thanks so much for your helpful post. Have spent so much trime going through the entire website with my wife.

    What would you recommend for a mid 30s couple with around $1M spare cash to invest in right now? We have always been self-employed so are actively looking at other business opportunities. We are implementing your SPX strategy (already got stung with the massive drawdown last week on Monday) but just concerned that any further investment into equities would mean too high a correlation in the event of a massive one day correction. Property prices don’t seem to be particularly attractive now too so just in a state of flux!

    Thank so much once again for being generous with your time. This is certainly a really outstanding website!!

    1. Mid-30s folks shouldn’t have $1m in cash sitting around to begin with. I recommend automating savings/investments
      But that’s not helpful to you, of course. Water under the bridge.
      Given that you’re now facing this market timing problem and you might regret deploying the entire sum all at once, maybe try to invest in the stock market slowly with monthly installments over the next 1-2 years.

  19. Hi ERN,
    It sounds like you foresee the Taylor Rule being demonstrated in our future, because inflation doesn’t go down on its own. Additionally, you don’t see a recession bailing out the Fed within at least the next several months. That implies 0.5% and 0.75% rate hikes for the foreseeable future, culminating in rates a lot higher than the markets seem to predict right now.

    1) What are your thoughts on the Fed Model* which posits that equity PE ratios are, or at least should be, a factor of treasury prices? If rates are going to 7-8%, doesn’t that imply an average stock PE ratio near (1/7.5=) 13 in order for the earnings yield to be competitive with treasuries? Does it make sense to own stocks at today’s PE of 18.5 and simultaneously assign this outcome with even a modest estimate of probability? *Fed model defined at:

    2) What would it look like if you had to make a case for an optimistic scenario, where inflation falls before rates have to get too high and corporate earnings keep growing, What has to happen for that outcome to occur? An end to the war in Ukraine? An oil price collapse? A fed pivot to aggressive QT rather than interest rates? Some obsolete economic assumptions? Is there any plausible optimistic scenario, where the bear market ends this year at less than 30% down?

    3) The five-year breakeven inflation rate* seems to be predicting a prompt collapse in inflation, and forward inflation predictions just fell below 3%! How do you explain the divergence of your view with the market’s view? Is this market predicting a major disinflationary recession, or is it just that TIPS are hitting their own version of a lower boundary? *

    1. Corporate profits should adjust for inflation (in the long run…) so the interest rate used should be the real/TIPS rate, right? Currently real yields are negative.

    2. All great questions.

      1: If interest rates go to 8%+, then the stock market is toast. At least in the short-term. It will recover nicely, once we have a moderation in rates again (like the long stock bull market post-1982). But painful in between!

      2: But the optimistic scenario is still valid. Ukraine war ends soon, political change in November, a modest slowdown in consumption, maybe even a small recession.
      And inflation slowly subsides.
      All that would mean that the bear market is likely restricted to no worse than -30%.

      3: Roughly 2.7% breakeven inflation could still entail 6%+ in Y1, and then quickly going down. So, there is some rationale behind that number. But you’re right, this number seems like a best-case scenario. Not sufficiently factoring in the upside risk.

  20. Conference Board LEI is down again in May (just published). Suggests (doesn’t prove) that we’re inching towards a recession.

  21. I greatly enjoyed the article and the chart of the effective Fed rate. It gives me hope that some serious rate hikes are coming.

  22. Great write-up. I always love a data-backed post on this topic, since it is easy to speculate. I think the last bit of advice is the most important (time in the market…). I’m using this drop as a buying opportunity, but staying cautious.

  23. Any thoughts on which yield curve is more accurate? The 10 year vs 2 year yield curve inverted recently but the 10 year vs 3 month yield curve did not invert at all.

  24. Karsten,

    Big fan of your blog, one of the more serious analytical ones. Fellow CFA here. NY Fed Williams mentioned yesterday he needed real rates to be positive, for a start. According to the St Louis Fed’s FRED series, real 1y rates are at -1.4%. Real 10y rates are positive, albeit at multiyear lows. I believe one component of the real rates are calculated from market breakevens. Could you share, why and how do you use the real FFR (as it is a short term rate vs long term inflation) as an indicator of positive or negative real rates?

    Thanks for your excellent ideas, once again.

    1. Good question. We can indeed express real interest rates in all sorts of ways. The “cleanest” way is to use way the Taylor Rule setup, i.e., using trailing inflation and the FFR.
      The reasons why a lot of Fed economists are ticking this way:
      1) the trailing inflation is actually observable and not dependent on forecasts. A 1Y future TIPS-implied CPI rate is dependent on the path of future rates, which would create a tautological problem if we try to use that for setting today’s FFR.
      2) It’s easiest to use the FFR because that’s what the FOMC sets. Everything else is just derived.

      Even if we go with the core-PCE, the lowest of the major indices at 4.56%, we’d need to 4.56%+x with x around 2%. Higher when using the overall PCE or CPI.
      Hence the urgency of rate hikes. The market is is not fully pricing in how serious the rate hike prospects are. Even with 3x 75bp this year, we’d only be barely positive in terms of real rates. Unless the core=PCE diminishes materially over the next 4 months.

      1. Curious to see the correlation between FFR (or 2y UST rates) vs S&P 500 specifically in the 1970s, pre- and post-Volcker, when the Fed made its mistake of easing too early causing a re-emergence of high inflation. I guess the 1970s are instructive because it looks like the Fed is studying the decade for its inflation playbook, going by what went down at Jackson Hole.

        1. Mentions of a “neutral rate” have been declining as fast as “transitory” did ten months ago. Still I wonder if FOMC members still subscribe to a theory that there exists a neutral rate loosely anchored to productivity growth which is approximately where we are now at 2.5%. August and September would thus offer an opportunity to view the trajectory of an economy that is neither being stimulated nor inhibited, according to theory.

          If “neutral” theory is wishful thinking (i.e. if an FFR below CPI is inherently inflationary at any nominal level) and if a commodities correction coincides with this experimental observation window, then the FOMC could hold back on rate hikes just in time for commodities to swing back the other direction and longer-term inflation expectations to set in.

          That would be the 2020’s equivalent of what Arthur Burns did in the 1970’s, when he chose to ignore “idiosyncratic factors” like energy prices, food prices, car prices, etc. As Burns’ advisor Stephen Roach writes: “The Fed poured fuel on the Great Inflation by allowing real interest rates to plunge into negative territory in the 1970s.” So far, all signs suggest real rates will be negative for perhaps another several months – and deeper into negative territory than they ever got in the 1970s. If the Fed pumps the brakes at 8%+ CPI, and real rates at roughly -5%, it’ll be a disaster IMO.

              1. He has a tendency to come up with useless facts and stats like that. I agree that falling inflation is good for the stock market. For example, I pointed that out in my post “Retirement in a High-Inflation Environment – SWR Series Part 51” where I looked at the impact of inflation on SWRs. The level of inflation is not important. The direction is. Falling inflation is good for retirees.

                Falling rates are correlated with falling growth. Falling rates are correlated with FOMC rate cuts to respond to economic recessions. The fact that falling rates are not very correlated with stock returns is due to the endogeneity of rates, i.e., there are a lot of other things happening at the same time. Mr. Carlson just discovered that a naive correlation between stocks andrates is not that informative. All else equal lower rates certainly support higher stock returns, but we can’t really do a clean “all else equal” exercise with the data, at least not the way he’s using the data.

                1. Hi Karsten,

                  What do you think about a Fed pivot, with inflation vs financial stability? Liquidity in the long end has all but dried up with everyone in one way bets.

                  It may still be possible to hike ST rates and buy the long end in sterilised operations, like Operation Twist in 2011. The thing is, how does sterilised curve flattening ops like Twist impact the equity markets?

                  I know we want to avoid the ghost of Arthur Burns, but how does the Fed practically go about balancing the 2 objectives, and what is the market going to see as a pivot?

                2. I don’t think there is a major threat of financial instability right now. The Fed will obviously monitor the situation, but we’re far away from a repeat of the 2008/9 episode. Banks are healthy. They benefit from higher interest rates.

                  The FED will pivot when it sees inflation come down.

          1. Thanks, great read. Should the Fed look at core PCE, or accept a higher inflation level, and pause prematurely on hikes, we could be looking at renewed inflation and the 10 year bear market of the 1970s. With an election year, they could be facing real political pressure to stop hikes when the economy enters recession. Hope Powell cares more about his long term legacy than short term noise.

            1. Core-PCE is their preferred indicator.
              I think the Fed was indeed held back by political pressures in 2021 because they didn’t want to “welcome” a new president with massive rate hikes. The same bad politics might again be at work in the fall this year. We shall see.

          1. Have you modelled for declining CPI along with rising rates, with a slight lag? Should the Ukraine war end, oil and food prices settle lower.

            4 year bear to 1974, then a 10 year bear to 1980 due to premature Fed easing in 1974.

            1. I don’t think inflation pressures are purely based on Ukraine. Inflation tool off well before Feb 24. The oil market has already priced in an end around the corner. But core inflation will stay strong.

  25. Love your blog. Thanks for the fantastic work you’ve done. You’ve convinced me to be a more conservative with my SWR, and I think I’ll benefit from that shift for the rest of my life. And now for my first comment:

    With equities having dropped in value so much since the start of the bear market last January, I wonder about the utility of establishing a glidepath at this point in my FIRE cycle and with the market in the condition it is. I’m at an aggressive 92/8 in total market stocks/bonds, and I’m hoping to fire in the next 6 months or so at about a 3.5% WR (3.0% or so with core expenses only). I’ve got around 250k in cash right now, and I’m waffling on what to do with it.

    1) I could double down on stocks to capitalize on likely (not guaranteed!) gains that historically tend to follow downturns like this.

    2) On the other hand, I could hedge against SORR by dropping much of that cash into bonds to establish something more like a 70/30 glidepath portfolio right away (or DCA it the lump sum).

    I can see pros and cons to either approach, but it seems to me like we’re *already* under the circumstances that a glidepath is supposed to pre-empt, so perhaps it would be best to double down on stocks now and reap the likely gains to come? Do these bearish circumstances make a glidepath less useful than it would have been if I were retiring into better market conditions or with a higher CAPE? Thoughts?

    1. Good question!
      The slide in stocks is now at about -18% since the Jan 3 high. Sounds large but it isn’t.
      In prior bear market events, it wouldn’t have been optimal to go 100% into equities until the drop reaches at least 40 or even 50%.

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