There have been a number of brokerage strategy reports recently describing a typical business cycle-driven bear market. The first stocks to decline tend to be smaller companies, at high PE multiples (meaning the best earnings are in the future, not the present), and in cyclical industries. Selling gradually rotates into larger, more mature (therefore lower PE) companies and into what are normally regarded as defensive industries. The rotation is typically driven by two factors: relative valuation and the gradual realization that even defensive companies suffer as spending declines in an economic downturn.
The whole process takes something like a year to play out, both in the real world and in the financial markets. The stock market, though, tends to bottom several (six?) months ahead of the economy. This is at least in part because government policy begins to shift away from its most restrictive stance.
This is a useful framework, which I think will continue to be a key part of AI-controlled trading strategies. So in a sense it’s a self-fulfilling prophesy. What I think is equally important, but overlooked in the cyclical bear scenario, are the implications of several external shocks. They are:
–the pandemic, predominantly now the negative effect on global supply chains, resulting in sometimes sharply rising prices for what goods are available
–the Russian invasion of Ukraine, which I see as triggering fundamental changes in the world market for oil and gas, as well as more temporary changes in agricultural commodity markets
–to a lesser extent (at present, anyway), the fundamental changes in the world semiconductor market being driven by the key importance of Arm Holdings and TSMC in their design and manufacture, and the precarious nature of the ownership of both firms