The sharemarket crash has only just begun and it will hurt

Add it all up, and right across the world investors are getting out of the market as fast as they can.

It is not hard to work out why. After more than a decade of pumping money into the economy, central banks have finally turned off the printing presses, and started putting interest rates up again. Inflation has taken off and will depress demand as real wages fall. The war in Ukraine has sent commodity prices skywards, and will cause widespread shortages while lockdowns in China will cut off the supply of manufactured goods and key components. The outlook is as bleak as it has been at any point in the last 50 years and possibly worse. Against that backdrop, it is hardly any surprise that investors are getting out.

How bad will it get? The historical record suggests we have already taken most of the hit. According to LPL Financial, there have been 17 bear markets, or near-bears that include 19 per cent-plus falls, since the end of the Second World War. On average they lasted 11.4 months, with an overall fall in the index of 29.4 per cent. If that is a guide, we will see another 10 per cent fall, and it will all be over by the time Christmas comes around.

Here’s the problem, however. Averages are just that – an average. Some bear markets are relatively mild (the 19.3 per cent correction over six weeks in 1988 was the smallest of the post-war era) while others are a lot more severe (the 56 per cent drop over 18 months in 2007 and 2008 was the worst since the 1930s). In reality, this one is likely to be right at the top of the scale. Here’s why. First, the record shows that the sell-off is far worse when it is triggered by a recession. Of the 17 bear markets, nine have been accompanied by a recession (the markets predict at least two recessions for each one that actually arrives). On average, those last for 15 months, and witness a 34 per cent fall. With consumer confidence plummeting, retail sales starting to ebb, and inflation cutting hard into everyone’s living standards, a recession now looks certain. The only real question is how deep it will be, and how long it will last. That means stocks will fall harder, for longer.

Next, valuations were already extremely stretched. We all knew that a lot of companies were wildly overvalued by the end of last year. During the pandemic, tech companies had soared to crazy levels, but as Covid faded it turned out that we didn’t all want to sit at home watching Netflix and ordering noodles after all. We like to get out of the house occasionally. Cash shells that raised hundreds of millions to buy something or other have turned out to be worth much less than the money they raised. The result? Over-hyped, flimsy companies, with no real business model, have seen their values crash spectacularly as the froth gets blown away. It will take some big falls to get back to realistic valuations again.

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Finally, policymakers are completely out of ammunition. The days of the “Fed Put” when, under Alan Greenspan, the Federal Reserve would respond to a market crash with cuts in interest rate and extra liquidity are now firmly behind us. Central banks cannot cut rates with inflation out of control. Nor can we expect governments to come to the rescue with higher spending and bigger deficits. They have already spent as much as they can. If anything, they will have to raise taxes to fix broken balance sheets, making the downturn even worse. This bear market won’t necessarily be up there with 2001 and 2008, when the index dropped by 49 per cent and 56 per cent respectively.

It might not necessarily match 1973 with its 48 per cent fall. But neither does it look like a mild correction before equities start to march higher again. There is still a lot of pain ahead – and this bear market will be a big one.

Telegraph, London