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Is the bear market nearing its end?

by , 19 May 2022
Is the bear market nearing its end?
The JSE crashed 14.45% between 2 March 2022 and 9 May 2022.

Similarly, the Dow Jones index in the USA is down 10.74% year to date of which half of this drop has been in the past month. And the S&P 500 index is down 14.75% year to date.

We hear about inflation, war, lockdowns, supply chain issues all as contributing to this bear market…

So, what is fuelling the market's drop - and are we near the bottom yet?
Where to find value in this bear market?
The defining move from growth to value started happening in 2021. 

Stocks like Prosus, Amazon and Naspers all plunged in share price but others like Jubilee, Argent and Santova’s share prices have exploded – doubling in less than 12 months.
If you want to know where to
find value stocks that could see you into early retirement then take a look here!

What’s causing investors pain right now?
Markets have been hit by the perfect storm.

Economies worldwide have just started to recover from the depths of their Covid-fuelled recessions in 2020. Commodity prices started soaring due to heating up economies and too slow delivery of supplies through a sluggish supply chain. Then the war in Ukraine happened – with huge sanctions instated against Russia, the world’s largest commodity supplier. Here’s how these factors are hurting markets right now:

Factor #1 – Continuing lockdowns in China
China remains on its Zero-Covid policy. That means it continues to lockdown towns and cities until there are no Covid cases. Shanghai has been under strict lockdowns for over a month now. The city alone has a population of nearly 30 million, with a GDP that’s around DOUBLE that of South Africa. While its difficult to get reliable figures out of China, estimates are that around 86 towns and cities were under lockdown at various stages in the past month.

These lockdowns mean a lot of manufacturers aren’t running at full steam. It also means ports in China aren’t shipping goods as efficiently as they should.

That’s part of why global supply chains are still hurting. It’s also one of the reasons for sky-high inflation – as imported goods are more expensive.

Fitch ratings agency recently penned an article detailing this specific fact – lead times for semiconductors out of China is rising, and freight times out of China to the US have DOUBLED, while shipping rates have increased six-fold.

Until China returns to business as usual this will continue negatively affecting the rest of the world, and the US in particular because of the large amounts it imports from China.

Factor #2 – Commodity inflation because of the Russia/Ukraine war
Russia is the world’s largest, or one of the largest, producers of many commodities like Palladium, wheat, oil and gas. Ukraine itself is also a huge producer of wheat, maize and barley. In fact, Ukraine alone, exports wheat to feed 400 million people annually.

I’ve written about the effect of this before. In short expect the price of fuel to remain high. In SA we’re seeing all-time highs, with the petrol price in June 2022 expected to be around R23.82 – R25.32 and similarly diesel to hit R23.76 – R25.26.

That means our fuel price is more than double the June 2020 levels of around R12 a litre.

Higher fuel prices mean higher agricultural input costs. That’ll lead to increased inflation.

Then, add in the fact most of Ukraine’s agricultural commodities won’t reach the market, and it will likely have a much smaller crop in 2023 – and it places even more pressure on agricultural commodities and with them food prices.

Factor #3 – Tightening money supply
After we’ve had TOO LOW interest rates for the past decade, and following huge government stimulus during the pandemic, central banks the world over are tightening money supply.

That means interest rates are heading up.

The SA Reserve Bank is expected to increase interest rates by 0.25% to 0.5% this week. The US Fed is expected to increase rates by up to 2% in the coming two years.

In the South African context, a 2% increase in interest rates isn’t big. But imagine this – you live in the US. You bought a $1 million home at the end of the pandemic at a 1.5% mortgage rate. Interest rates now go up by 2%.

Suddenly your interest repayments on this home has more than DOUBLED.
Monthly repayments soar from $3,700 a month to $4,800 a month. That $1,100 a month difference will hurt a lot.

By increasing interest rates a couple of things happen. Firstly, it puts downward pressure on property prices. Or at least bars them from continuing to go up.

Secondly it decreases disposable income of consumers. And that leads to less spending. Lower consumer spending decreases the demand for imported goods, cars, fuel, food and restaurants. All of this serves to curb inflation.

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When will the markets stop dropping?
Markets are dropping because interest rates are rising faster than most thought would happen a year ago.

This is because inflation has soared due to a string of factors working together.

The higher interest rates go the higher the ‘risk free rate’ becomes. This is a number analysts use to value shares, and it is based on the US 10 year government bond. The rationale is if the US 10 year bond is say 3% - shares have to outperform 3% by a risk adjusted margin to make the risk of investing in uncertain shares worth not investing in bonds.

Now 3% is low. But in August 2021 the US 10-year bond was at a 1.21% yield.
So, its yield has already doubled in less than a year. Predictions are the yield will increase to around 4% before inflation comes under control.

That means there’s still further downside for stock markets in general.

I suspect between 5% and 8% further downside for the coming year.
That doesn’t mean all stocks are dropping. Many companies are actually still growing profits, and growing them much faster than inflation. You simply have to look for the ones that have attractive growth levels, low debt and hopefully a dividend or share buyback plan in place…

Just this week I told Red Hot Penny Shares readers about a property company that’ll pay a more than 10% dividend this year, a property developer that’s grown profits by triple digits, and a precious metals and base metals producer that’s set to see triple digit revenue growth in the coming year. Another long time favourite of mine, Santova, just announced earnings growth of more than 160% - and its share price has soared by 144% in the past 12 months and 24% in the past month alone. This shows there’s definitely still opportunity to profit in small companies!

Here's to unleashing real value

Francois Joubert
Editor, Red Hot Penny Shares

PS.  I’ve just reviewed and updated
my top five  penny stocks to buy in 2022 given this bear market,  I see these five stocks doubling in the next 12 to 18 months. 

Is the bear market nearing its end?
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