Sep 13, 2022, 2:04 PM ET

Bear Market Bounce or Stock Market Bottom?

Recent equity rallies following summer gains are currently classified as "bear market rallies" rather than a genuine transition to a new bull market, as key inflection conditions remain unmet.
A genuine bull market inflection typically requires a combination of: deeply depressed valuations, a slowing rate of economic deterioration (second derivative improvement), peaking policy rates/inflation, and extremely negative sentiment/positioning.
Bear market rallies are a common historical feature; virtually all bear markets contain them, often appearing frequently and strongly (e.g., six strong rallies during the 2008 financial crisis).
These rallies average roughly 15% in size and occur over approximately 1.5 months, often triggered by investors fearing they will miss the "hope phase" of the subsequent bull cycle.

Global market valuations are currently trading near median levels, while US valuations remain above their long-run average, inconsistent with pricing in a recession.
Leading economic indicators, specifically PMI and ISM, have not yet fallen to levels that typically signal a confirmed recession.
Interest rates and inflation have not peaked; central banks in the US and Europe have recently adopted a more hawkish stance following the Jackson Hole meeting.
Investor positioning and sentiment indices have not reached the extreme stress levels associated with market bottoms.
Goldman Sachs expects most equity markets to fall approximately 30% from their peaks; some markets are close to this level, while the US has further to fall due to higher valuations.
In a US recessionary scenario, colleagues project the S&P 500 to reach approximately 3,150 (based on internal models, not a definitive forecast).
Market performance divergence is driven by currency strength (dollar appreciation impacting non-USD markets) and sector composition, with Europe facing higher inflation risks due to energy exposure and China weakness.

The current downturn is categorized as a "cyclical bear market," driven by economic cycles maturing, higher inflation, rising interest rates, and recession fears, distinct from structural or event-driven downturns.
Structural bear markets (e.g., 2008, 1930s) involve asset bubbles, high leverage, and banking crises, typically causing 60% declines over three years with a decade-long recovery.
Event-driven bear markets are triggered by exogenous shocks (e.g., pandemics, wars), usually falling 30% quickly over 6–12 months with rapid recoveries.
Cyclical bear markets typically see falls of roughly 30%, occurring over longer periods than event-driven downturns, with recoveries contingent on policy rate peaks and inflation easing.
Future economic resilience is supported by healthy private sector balance sheets, strong bank regulation, robust corporate balance sheets, and government fiscal support, though disposable income is under pressure.

The "hope phase" of the next bull market will likely be strong and last about a year as valuations expand, but subsequent returns may be lower than the post-1980 era.
The post-financial crisis era of high returns was driven by four unique secular trends that are now reversing: disinflation/zero interest rates, deregulation/supply-side reforms, geopolitical de-escalation, and rapid globalization.
The emerging cycle faces "fatter and flatter" market conditions with lower aggregate returns, higher volatility, and a shift toward idiosyncratic alpha rather than macro-beta.
Fiscalization is replacing monetization as a primary driver, with increased government spending on infrastructure, defense, and decarbonization.
Tighter supplies of labor and energy are expected to reduce margin expansion compared to the previous cycle.

Diversification across geography, industries, and factors is now recommended, contrasting with the previous cycle where concentrating on US technology was optimal.
Future success depends more on valuation discipline and sustainable balance sheets rather than growth at any cost.
Recommended strategy involves a "barbell" approach:
- Defensive holdings in stable growth companies with predictable recurring revenues and strong balance sheets.
- Overweight positions in deep value sectors, specifically resources and commodities expected to generate growing dividends.
- Selection of quality mainstream and profitable technology companies.
Investors should wait for specific signals from Goldman Sachs' "GSBLBR" (bear market indicator) and "risk appetite index" before anticipating high probability returns over the next three to six months.
Current indicators do not yet provide a high degree of probability for positive market returns in the near term.