The world is in a bear market, or a plunge in stocks of 20 percent.
In the U.S., the Dow Jones industrial average and the Standard & Poor’s 500 index defy the typical bear definition, since the large companies within those indexes have fallen only about 14 percent from their highs hit in 2015.
The pure definition of a bear market is a decline of at least 20 percent. But the world hit that mark Thursday as the MSCI All-Country World Index sunk into the bear territory as investors worried once again that weakness in European banks could erupt into a financial crisis.
Market watchers have been observing troubling signs building throughout world markets since summer. And while the Dow and S&P 500 still are not officially in a bear market, the carnage has been great.
Many stocks have plunged much further than 20 percent, and investors have lost about $2 trillion in the S&P 500.
“The S&P 500 is just pulling the wool over your eyes,” said Doug Ramsey, chief investment officer for the Leuthold Group. “This is definitely a bear market. It just hasn’t registered yet.”
The Dow and the S&P 500 are made up of the largest, most solid stocks of the stock market, so they tend to be the last to crumble when stocks overall are plunging. From their highs last May, the large companies have dropped about 14 percent. Thursday the Dow lost 254 points, declining to 15,660.
Smaller companies, which are in the Russell 2000 index, have declined about 24 percent. And the smaller companies that investors liked because they were expected to grow the most have dropped 29 percent.
Likewise, the Nasdaq composite index, which includes technology stocks investors bought for their brisk sales, has disappointed investors. A slowing global economy has cut into those sales, and investors consequently have sold the stocks — setting off an 18 percent decline.
Perhaps most disconcerting are transportation and industrial stocks. They can be the canaries in the coal mine for oncoming recessions.
Transportation companies ship the goods that people buy or companies need to build buildings or make items in factories. When the economy slows, shipping does too, as businesses and individuals cut back on purchases. Consequently, investors have been watching transportation stocks in dread for months. They have declined 24 percent.
The industrial sector, companies which make the goods that are sold in the U.S. and around the world, is also down, but less than the transportation stocks: 14.5 percent.
The industrial and transportation stocks “pick up on the growth concerns” for the economy, said Ed Clissold, analyst for Ned Davis Research. “Over the past year, economists called for a pickup in growth, but it hasn’t followed through and the stocks are showing a pickup in fear.”
Anyone who went through the 2008 market crash and subsequent recession gets nervous when they see investors nervous about banks, and those worries have been percolating to the surface lately.
The issue started with concerns about bank exposure to energy companies, with many believed to be at risk of collapse now that oil has plunged from about $140 a barrel to $27 recently.
“Banks have said energy is just a small part of their loan portfolio, but that’s what was said about subprime loans” prior to the 2008 financial crisis,” said Clissold. “We learned that banks might not have a handle on the risks in their portfolio.”
Bank stocks in the U.S. are in a bear market, with a decline of 21 percent, and European banks are in even worse shape. That’s opened questions that came up during the 2008 financial crisis: If some banks are sick, can this infect others? And if banks are in a weakened state, there is a risk for the economy because fragile banks — or banks worried that other banks are fragile — hold onto cash instead of lending. Without loans, companies cannot grow as much as they would, so the economy can spiral down.
Says Clissold: The decline in bank stocks “is a very bad sign. It could mean tighter lending standards and less loans.”
Despite the distress of many companies, and worries about a possible recession, even a bear market will not mean that the U.S. is destined for a recession, Clissold said.
The slowdown in energy and industrial companies, along with nervousness about lending, does increase risks to the overall economy, according to Ned Davis economist Veneta Dimitrova. But stocks have fallen on average about 19 percent during major declines that have not ended in recession, Clissold said.
Ramsey said he can explain the downturn that has occurred so far primarily by the fact that investors had far too lofty expectations for profits and paid far too much for stocks given the weak profit picture. The downturn so far has brought stock prices down to more reasonable levels, and he said he has begun buying some of the battered small company stocks.
But, he adds, “this is a human system.” If corporate executives get scared from the downturn in the stock market, he said, they may say: “I won’t buy new equipment; I won’t hire new people.” Then, said Ramsey, the economy follows the stock market down.
Twitter @gailmarksjarvis
