Wall Street has a rule for how equity bull markets end: the economy rolls over or the Fed tightens until something breaks. Neither is in place right now, but rate risk is creeping back.
The backdrop shifted further on Thursday. Brent spiked above $105, US producer prices rose the most in three months and global bond yields from Washington to Berlin gained. Fed funds futures are pricing in about a 71% chance of a quarter-point hike for the Federal Reserve next week.
For the current bull market in stocks, a hike on Wednesday isn’t the concern. It’s a full-fledged hiking cycle, not a single move, that really threatens the bulls, according to historical data.
The chart below maps 12 S&P 500 bear markets of 20% or more since 1945, plus four near-misses of 18% to 20%. Six bear markets followed a hiking cycle straight into recession. Three came after rate hikes without an economic downturn, one coincided with a recession during the Covid pandemic, and just two had neither. For this comparison, a hiking cycle means at least two moves totaling 100 basis points or more.
In the hike-linked cases, the market typically topped out about eight months before the final rate increase. So if a sequence starts, history suggests equities do not peak on the first move.
The rule mostly holds, with some exceptions. The 1953 and 1960 recessions produced no bear market at all, and the mild 2001 downturn sat inside the second-deepest bear market of them all.
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Today’s setup has no exact precedent. The S&P 500 Index is sitting about 3% below its August record, there’s no recession, the Fed is two years into an easing cycle, and its last hike was more than three years ago.
The closest comparison is the mid-1990s. After the Fed cut in 1995, it made a single move higher in 1997 — no cycle followed and the bull market ran for three more years. After another cut in 1998, a hiking cycle began in mid-1999, with the S&P 500 peaking nine months later at the height of the dot-com bubble before sliding into a recession-linked bear market.
For the size of a bear market, history shows investors need to look past what triggered it. The rate cycle typically sets the market up, but the recession dictates the fall.
Recession-linked bear markets fell a median 36% over 18 months and needed more than three years to regain their previous highs. The non-recession variety lost 28% over eight months and were back at a record inside two years. Every bear market deeper than 35% in this sample sits in the recession-linked category. And the equity peak led the recession by roughly 10 months, meaning a recession-driven bear market begins well before the economic slump is visible.
This is roughly where the sell side sits too. “While Fed tightening may weigh on markets in the near term and rate hikes may create periods of volatility, we continue to view the broader earnings backdrop as supportive,” said Tobias Keller, investment strategist at UniCredit SpA. “Provided the Fed’s hiking cycle remains broadly in line with current expectations, and growth and earnings remain resilient, investors should be careful not to confuse short-term volatility with a deterioration in the medium-term outlook for equities.”
Which puts the labor market, not the Fed, at the center of the map.
Outside the 1980-1982 double dip, every recession-linked bear market began with the unemployment rate at or near its cycle low, between 3.4% and 5.2%. August’s 4.1% figure sits squarely in that band, but a low jobless rate doesn’t preclude a bear market or recession.
For now, the scale of the rate cycle matters most, while the economic backdrop would help determine the extent of any weakness.
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