After the latest price falls the tech-heavy Nasdaq index is now down by 30pc since the start of the year, while the S&P 500 index has fallen by 22pc over the same period.
Things are almost as bad on this side of the Atlantic. In the UK the FTSE 250 index is down 21pc since the start of 2022 – the FTSE 250 index, over half of whose constituent companies’ sales are in the UK, much better reflects what’s happening in the British economy than the better-known FTSE 100, of which less than a quarter of individual company sales are in the UK.
Share prices have also taken a pasting on the European mainland with the Eurostoxx 50 index of the 50 leading eurozone shares down by 20pc so far this year, with the French CAC and the German DAX both down 18pc over the same period. The Iseq index of Irish shares has lost 25pc of its value this year. What this shows is that all of the major equity markets are now either already in a bear market, which is defined as a 20pc fall in share prices, or getting perilously close to one.
So is the emerging bear market a sign of a recession to come?
Post-Covid inflation has proved far more persistent than most economists had been predicting. Irish inflation is at a 38-year high with the consumer price index leaping 7.8pc in the year to May. Ireland isn’t an inflation outlier: UK inflation is now at a towering 9.1pc while US inflation has hit 8.6pc.
Persistent high rates of inflation are forcing central banks to jack up interest rates aggressively. The ECB has signalled 0.25pc increase next month with a further increase, possibly of 0.5pc, to follow in September. Across the Atlantic the Fed has already struck with the biggest rate rise in 30 years, a massive 0.75pc, while the Bank of England has increased UK rates five times since last December.
While higher interest rates may be necessary to rein in rapidly rising inflation, the price may be a severe economic slowdown or even a full-blown recession. It is these fears of a recession that have caused the share price slump as investors sell in anticipation of lower future company earnings.
“Interest rates are rising aggressively. There is the possibility of a policy error if central banks raise rates too quickly”, Davy Stockbrokers chief economist Conall Mac Coille says.
Share prices have enjoyed an incredible run in the near decade-and-a-half since the 2008 crash. Even after this year’s price falls the S&P 500 is up almost five-fold on its May 2009 trough while our own Iseq has tripled in value.
Driving share prices have been the ultra-low interest rates that central banks everywhere have used to nurse their battered economies back to health.
As recent events have demonstrated, the era of very low interest rates is now drawing to a close. To equity markets grown used to virtually infinite amounts of cheap money, the new reality of dearer money has come as an unpleasant shock. How many businesses will be exposed as mere interest-rate arbitrageurs – borrowing for virtually nothing to finance the purchase of slightly higher-yielding (but much higher-risk) assets and pocketing the difference – in the months ahead?
Global M&A (mergers and acquisitions) activity hit $5.65trn last year, smashing the previous record of $4.55trn set in 2007. Buyers have been able to use cheap money to snap up everything from British supermarkets to Italian telephone companies.
Higher interest rates remove the rocket fuel – the cheap money – that has powered the post-crash boom in asset prices, including equity markets.
However, while higher inflation and the resulting higher interest rates may be bad news for investors, it is a different story for savers and many borrowers. Rising interest rates will banish negative rates and mean that savers will once again be able to earn a worthwhile return on their money.
While borrowers will initially feel the pain of these higher interest rates, this will over time be offset by the reduction in the real value of their debts as inflation does its work. It’s also potentially good news for banks, with the share prices of both AIB and Bank of Ireland bucking the recent bearish trend.
Since the start of the year the Bank of Ireland share price has risen by a third while AIB share price has risen by 19pc. However, the share price of the other quoted Irish bank, Permanent TSB, has fallen by 16pc over the same period. European banks have done less well as investors fret about the possible impact on their balance sheets of Russia’s war on Ukraine. The Euro Stoxx index of the 50 leading eurozone banks has fallen by 17pc since the start of the year.
Having fired the interest rate weapon, central banks must now hope it works by bringing down inflation without inflicting too much economic damage in the process.
“Valuations were stretched at the start of the year. Higher interest rates have led to a rebound in valuations … On balance I think we will get through without a second [the Covid-induced lockdown being the first] recession”, Mac Coille says.
