TheStreet.com: Bear Market Carnage - Who Will Be Hit First?https://realmoney.thestreet.com/articles/09/28/2015/bear-market-carnage-who-will-be-hit-first
Bear Market Carnage: Who Will Be Hit First?
By Jim Collins
September 28, 2015
Carnage. It's a one-word description of what's going on in the markets. To really understand the force and violence of selling pressure, one must look beyond the three "major" indices. The DJIA, S&P 500 and Nasdaq composite are all trading in correction territory, as of today's noontime pricing. All three major indices were down at least 10% from the recent mid-July market highs.
That's all well and good, but if you lift the hood, you are going to find many sub-indices, non-US indices and asset classes that waved goodbye to correction territory. They are now being gripped by the jaws of the bear.
A bear market is generally defined as a decline of at least 20% from recent highs, so twice as damaging as a correction. But there's a subtext to these words that you might not find by Googling them.
The term correction implies a temporary condition that is followed by a return to an uptrend.
The term bear market implies an extended period of lower stock prices. That's the difference. Bear markets last; corrections don't.
And it is the duration of bear markets that makes them so darn unpleasant. The ramifications are felt widely, and so much more so, when there is absolutely no yield anywhere else in the world, but for high-yield and emerging markets bonds -- markets that are experiencing declines worse than those felt in the U.S. stock market.
But can't an investor just wait it out? If you are an individual, you might be able to, but remember that individuals represent (according to Goldman Sachs) only 34% of direct U.S. stock ownership. Institutions own the rest of the shares outstanding, and many of them -- for different reasons -- need equities to perform well in order to meet their obligations.
That's the problem with this Fed-QE, marshmallow-world fantasyland that has been in effect since the end of 2008. Capital gains have replaced yield as a means of generating required returns, and that is just not sustainable.
This environment has encouraged risk-taking, and as risk is removed, the nominal wealth of the world's economy is lowered. Simply put, people are worse off.
Who gets hit first?
Investment banks. Lower equity prices lead to less deal flow, and the bulge-bracket banks have supported themselves through fees generated from stock and bond offerings. That can -- and will -- dry up very quickly.
State and local governments. The perilous finances of some of America's most populous cities and states has been well-reported. But the key point isn't that deficits are being run -- although they are, and cities like Chicago are implementing draconian measures to try and stem the bleeding -- it's that long-term liabilities are unfunded to an even greater degree when fund returns don't meet their benchmarks. An example would be the Teachers' Retirement System of Illinois. TRS had 41.2% of its assets in stocks as of March 31. The recent pullback in equity prices could put their already underfunded pension plan into serious financial jeopardy.