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Rules of thumb for a bear market

The western world is heading into recession while interest rates rise. As two-headed monsters go, that’s about as scary as it gets for investors. While recession sucks value from their equities, rising interest rates do the same for their fixed-coupon bonds. Then the ensuing stagflation feeds a vicious spiral that drags down values still further. Welcome to the bear market just around the corner.

Yet it is worth asking whether a recession is all but certain and whether its investment concomitant – a bear market – is all but present. True, on bad days – for instance, the FTSE 100 index closed 2.3 per cent down the day before I wrote this – the manic depressives among the investment commentariat aren’t in any doubt. However, perhaps they are simply proof that Benjamin Graham’s ‘Mr Market’ is always with us, ready to grab at the extreme outcome if at all possible. So it might pay to be a bit circumspect and ask simple questions, such as: what are the chances of either or both a recession and a bear market?

Start with recession since that is more likely to lead to a bear market than the other way around. To help with perspective, let’s use a rule of thumb labelled the Sahm Rule, devised by a US economist, Claudia Sahm, a couple of years ago. Granted, this indicator was framed within the context of the US economy so it may work less well applied to UK data. Even so, it is a good way to get the thought process going.

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