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Two key risks for bear markets present themselves

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Two key risks for bear markets present themselves

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Traders work on the floor of the New York Stock Exchange (NYSE) on December 08, 2021 in New York City.

Spencer Platt | Getty Images

Has the risk of a real bear market increased on Wall Street?

A standard correction has already arrived for the Nasdaq Composite. However, the larger question is whether tighter central bank policies in the Western world will lead to larger declines than we have already seen in major averages and among individual stocks.

Many years ago, legendary investor Stanley Druckenmiller told me that his historical analysis suggested that there were two significant bear market triggers for stocks: rising interest rates and the start of war. .

Now we seem to be looking at a barrel of both as the Federal Reserve has now acknowledged that it expects rate hikes throughout this year and a reduction in its holdings of Treasuries. Meanwhile, slashing is taking place from the Kremlin to Kiev and from Tiananmen to Taiwan.

Shrinking the Fed’s balance sheet, known as “quantitative tightening,” would be a powerful complement to rate hikes to reduce excess liquidity in the markets. If history is any guide, it would also weaken equity markets further during the tightening cycle.

The mere threat of these events, ahead of the Fed’s admissions, sent markets spinning, wringing out speculative excesses in cryptocurrencies, meme stocks and SPACs, or special purpose acquisition companies.

Shares of AMC Entertainment and GameStop are each down about 80% from their memetic highs. Robinhood and Coinbase shares were stolen.

Weak assets fall first before being followed by less risky market bets.

The NYSE Advance/Decline line is rolling as the number of new 52-week lows has exploded.

Certainly, some sentiment indicators like the VIX (or fear indicator) have recently reached extremes, suggesting that an oversold rally will ensue. However, I do not believe that this tumult is almost over in the medium and long term.

A time of heightened risk worldwide

Geopolitical risks are increasing rapidly. The United States has put its troops on high alert and NATO has placed standby forces and hardened positions in Eastern Europe as the threat of a Russian invasion of Ukraine continues to grow . NATO allies have also reportedly sent weapons to Ukraine to bolster its defences.

Russia was pessimistic about Washington’s response to its demands that Ukraine never enter NATO.

Earlier this week, the US State Department asked family members of diplomats and embassy staff to leave Ukraine, in a sign of growing concern that Russian President Vladimir Putin is not bluffing. It is a belief supported by the 100,000 Russian troops, the weaponry and logistical support amassed on the Ukrainian border and reports that Putin is trying to install a pro-Russian president in Kiev.

Moreover, it is interesting to note that Russian stocks, which performed well last year in line with oil prices, have fallen in 2022.

Against a backdrop of rising oil prices and a flight to quality into US Treasuries, the combined messages from these markets look ominous.

Add to those concerns new Chinese overflights in Taiwan, prompting the Taiwanese air force to rush in and chase down 39 fighter jets over the past weekend.

If there is even an economic war between the West and Russia resulting in severe sanctions, such as stopping Russian energy exports, banning Russia from using SWIFT – a transfer mechanism international financial institutions – or the imposition of export controls on goods destined for Russia, the global economic stakes rise dramatically.

The stakes are even higher if Putin and Chinese President Xi Jinping coordinate their efforts to destabilize Western alliances and sever already frayed relations.

Such a set of developments could freeze central banks in place and result in a friendlier Fed.

That would be relatively better for risky assets, but far from a favorable global environment, especially given a three-year bull run, high valuations and speculative excesses in some corners of global markets.

The pandemic-induced bear market in 2020 lasted 21 trading days, with the S&P 500 falling 34% in the most compressed bear market on record.

I am considerably less optimistic that the next bear market, if indeed the beginning of a bear market, will end so quickly or do so little damage.

Cash may no longer be trash in 2022.

– Ron Insana is a CNBC contributor and a senior adviser at Schroders.

Two key risks for bear markets present themselves

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