Is the next stock bear market around the corner?

Is the next bear market around the corner?

Bear markets have a tendency to sneak up on investors and are rarely signposted ahead of time. With this in mind, are there any clues that investors can spot ahead of time?

Spotting signs of an impending bear market and recession

With the stock market recently hitting all-time highs, investors may be wondering if a bear market and economic recession could be on the horizon. While no one can predict precisely when downturns will hit, there are often clues that emerge ahead of significant market corrections. Being aware of these signs can help investors position their portfolios more defensively or, in case of contract for differences (CFDs), exchange-traded funds (ETFs), futures, and options or spread betting go short stocks and/or indices.

Here are some key indicators to watch out for:

Inverted yield curve - This occurs when long-term bond yields fall below short-term yields, indicating declining confidence in the economy's future growth prospects. Every recession over the past 60 years has been preceded by an inverted yield curve.

Un-inverted yield curve – Conversely, when the yield curve un-inverts, or normalizes, in all cases but one over the past 50 years, a recession followed. This is also the case once the first rate cut has been made after a hiking cycle, as is likely to be the case when the Federal Reserve (Fed) cuts its interest rates for the first time since March 2020 on the 18 of September 2024.

US yield curve slope and recessions since 1980 chart

Slowing profit growth - When corporate profit growth begins decelerating across many industries, it signals contractions in economic activity. Faltering earnings tend to foreshadow stock multiple contractions as well.

According to GuruFocus as of the end of August there seems to be no need for concern, though. The S&P 500 Price-to-Earnings (PE) ratio is 29.51, slightly above its typical value range from 20.73 to 28.89. Having said that, the end of 2025 S&P 500 PE ratio with forward estimate is at 21.57, towards the lower end of the average.

S&P 500 PE ratio with forward estimate chart

Overheated equity valuations - Peak PE ratios coupled with high investor sentiment can indicate a market top is approaching. Extended valuations reflect overly optimistic expectations that may not materialize.

As shown above, the S&P 500 does not display overly optimistic PE expectations but when zooming in on the so called ‘magnificent seven’ stocks, the average PE ratio comes to 38.30 (according to Google Finance on 10/09/2024). These are significantly higher than those of the S&P 500 but compared to their mid-July valuations of 52.29, have already come down by a considerable amount.

Still, with the magnificent seven stocks now accounting for 32% of the S&P 500 market value, both close to this year’s record extremes, the air for the bulls might be getting thinner. This share has increased by 10% in just 1 ½ years and is even 10% higher than the largest stocks share during the 2000 Dot-Com bubble. Such a large concentration poses a significant risk to the entire stock market since any large sell-off in these stocks would have a disproportionally large impact on the S&P 500.

Spiking commodity prices - Oil and other commodity prices often spike ahead of recessions as supply/demand imbalances emerge. Rising inflation also tends to squeeze consumer and business spending.

With the oil price trading in 16-month lows and inflations gradually falling back towards the US Fed's 2% target, there seems to be no reason to fret for the time being.

Tightening monetary policy - When central banks raise interest rates and tighten credit conditions to cool an overheating economy, it can slow growth and spark recessions as lending activities slow.

This point may turn out to become a problem in the future as the Fed, and other central banks, haven’t historically always been able to avoid a recession as they tend to stick to restrictive monetary policy for too long. This time round may be no exception as US non-farm payrolls (NFP) have been on a downward trend since March while the unemployment rate has risen from 3.8% to 4.2%.

US unemployment rate and non-farm payrolls chart

US stock indices got a scare and dropped between 6-to-11% within days on the back of disappointing US labour and unemployment data at the beginning of August and may do so again in the, especially in US election years, seasonally for stocks unfavourable period of the year between September and October.

Behavioural Finance - Technical analysis is an additional, powerful tool in an investor’s arsenal to spot when stock indices are running out of steam and beginning to form tops.

Weekly S&P 500 candlestick chart

The S&P 500 has been in a bull market since October 2023 and mad a record high in July at 5,669.67, a level it nearly revisited at the end of August before keeling over.

Since the 2023-to-2024 uptrend line remains intact and as a series of higher highs and higher lows can be made out on the weekly chart, the long-term uptrend remains valid. This situation would change, though, if a fall through the uptrend line and, more importantly, the August low at 5,119.26 were to unfold.

No single indicator provides a perfect prediction. But tracking an array of economic, market and technical metrics can give investors better odds of spotting changes in the business cycle and markets. Paying attention to these clues can help prevent overexposure to equities just as a new bear market emerges.

For those interested in learning more about these trading methods, consider opening a demo account to practice without risk. If you're ready to start trading, you can open a trading account with IG. Our trading platform offers a wide range of tools and features to help you navigate market conditions, whether bullish or bearish.

Remember, trading carries inherent risks, and it's essential to have a solid understanding of the markets before investing. For more information on how to approach different market conditions, check out our guide on how to trade online.