Muzinich Weekly Market Comment: A Practical Bear Market Guide

April 14, 2025

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If we relied solely on the Bloomberg World Large & Mid Cap Price Return Index, a rolling 5-day total return of +2.2%¹ might suggest that all is well in the world. However, this average masks significant inter-period volatility; a classic case of Simpson’s Paradox in action. Beneath the surface, our preferred equity volatility indicator, the VIX, surged to levels seen only during the Global Financial Crisis and the height of COVID. Meanwhile, its bond market equivalent, the MOVE index, spiked to such extremes that it prompted concern from the US administration, which responded with a 90-day pause on higher reciprocal tariff hikes (excluding China)². President Donald Trump acknowledged that his tariff policy might be creating “transition problems^3.”

In these volatile conditions, investors should remain alert for signs of market dislocation, a classic signal that capital markets may have entered a new regime, in this case, a potential bear market. Looking at government bond markets, the US yield curve is bear-steepening, while Germany’s yield curve is bull-flattening. To illustrate this divergence, at the 10-year point, US yields have risen by 20 basis points (bps), while German yields have fallen by 7bps, despite both US and German overnight interest rate markets pricing in an additional 25bps policy cut in 2025 compared to the start of the month⁴.

This repricing reflects growing investor skepticism toward the US administration’s policy direction. This can also be seen in the foreign exchange market, where the US dollar continues to depreciate against major global currencies. Notably, the Swiss franc appreciated by over 5%, a further warning sign that we may be in a bear market. The Swiss National Bank (SNB) proactively cut its policy rate to 25bps at its most recent meeting, in what appears to be an attempt to discourage such capital inflows into its domestic banking system. This raises a question: could Swiss policy rates turn negative once again?

For US corporate credit markets, the dislocation was evident as high yield (HY) bonds outperformed investment grade (IG) bonds which drew down more. This unusual dynamic reflects both stress in the US government bond market, and overall healthy corporate balance sheets, with low leverage, manageable maturity walls, strong cash positions, and solid interest coverage ratios⁵. Additionally, the banking sector remains well-capitalized, providing further stability.

Finally, both equity and commodity markets continue to reprice in the face of rising recession fears. In equities, small caps underperformed large caps, while emerging markets lagged developed markets; a typical risk-off pattern. In commodities, the divergence was equally telling; energy and industrial commodities declined, while precious metals rose, reflecting a defensive shift toward safe-haven assets. All signs point to a bear market.

Bear Market Stages

From an investor’s perspective, a bear market typically unfolds in seven stages. It begins with price action adjusting to rising risk premiums, driven by deteriorating expectations. Investors then start reducing exposure to the epicenter of the risk, pushing prices lower. This is followed by negative NAV performance, triggering outflows and prompting active liquidity management. The fourth stage, often the most painful, is the liquidity vacuum; a period where outflows accelerate and forced selling overwhelms fundamental valuations, exacerbating market stress.

We believe we are at stage three of the bear market, and there is a case to be made that we’ve entered stage four this week, as evidenced by recent price action in US Treasurys and equity markets. There is also supportive evidence from fund flows into debt funds: developed market high-yield debt faced outsized outflows of US$16bn (around -2.7% of AUM), the largest on record since 2000⁶.

Typically, stage four is short-lived, with episodes like March 2020 and February 2009 serving as prime examples. In contrast, stages five through seven often unfold more gradually, as investors begin the slow climb up the proverbial “wall of worry” and confidence is cautiously rebuilt.

Stage five marks the “bottom-fishing” phase of the bear market. Confidence remains low and uncertainty persists, but some investors are drawn in by attractive valuations, others by the belief that the worst-case scenarios are already priced in. At this stage, positive news begins to outweigh negative news, although conviction is still fragile.

In stage six, liquidity management measures are lifted, and policy announcements—monetary or fiscal—often act as catalysts, restoring investor confidence. Risk appetite returns, and capital starts flowing back into markets.

Finally, stage seven signals the formal exit from the bear market. Ironically, this often occurs while the economy is still in recession, highlighting the forward-looking nature of financial markets⁷. (See Chart of the Week)

In trying to explain why investors and market price action often front-run or diverge from economic forecasts, it’s often said that economic forecasting is like driving a car blindfolded while taking directions from someone looking out the rear window. While perhaps a little harsh, the analogy highlights a key limitation: economic data is backward-looking, while markets are forward-looking. That said, we believe economics still offers critical insight, not necessarily in timing market moves, but in identifying the nature of the bear market investors are navigating.

Bear Market Categories

Understanding the type of bear market can be as valuable as pinpointing the bottom of the market. Economists typically define bear markets in three broad categories.

The first is a structural bear market, triggered by deep-rooted imbalances within the financial system, often brought to the surface by a Minsky moment, where excessive leverage and speculative behavior unravel abruptly. Historical examples in the US include the 1929 stock market crash and the Global Financial Crisis in 2008. Structural bear markets are severe; the average S&P 500 drawdown from peak to trough is around 57%, and the associated economic recession tends to last an average of 42 months⁸.

The second type is the cyclical bear market, which typically results from central banks tightening monetary policy too aggressively or failing to respond to economic overheating in time. This policy misstep tips the economy into recession, leading to rising unemployment, shrinking corporate profits, and a broad loss of consumer and business confidence. In such episodes, the average drawdown in the S&P 500 is about 31%, with the corresponding recession lasting around 27 months⁸.

The third type is known as an event-driven bear market, caused by sudden and unexpected external shocks that derail economic momentum. These shocks might include geopolitical conflicts, oil price spikes, or pandemics. Although alarming, event-driven bear markets tend to be shorter and less severe than structural or cyclical ones. On average, the S&P 500 falls by 27% from peak to trough, and the recession that follows typically lasts just 8 months⁸. (See Chart of the Week)

Implications

The good news is that this does not appear to be a structural bear market. For now, the current episode most closely resembles an event-driven bear market. What economists are actively debating, and what some investors may be fearing, is whether this event could ultimately tip the economy into a cyclical recession. Even before “Liberation Day,” there were already signs that the US economy was losing momentum. A combination of restrictive monetary policy, sluggish activity data, and declining business and consumer confidence had started to weigh on growth. The only piece yet to fall into place—the usual lagging indicator—was a rise in unemployment.

For this to remain an event-driven bear market, it will be critical in the coming days and weeks that positive news flow, particularly around tariffs, outweighs the negative. Positive signs could include progress on reciprocal tariff agreements and a willingness from the US and China to return to the negotiating table. Equally important is the continued presence of the central bank “put”, that is, clear and credible communication from global central banks—and particularly the US Federal Reserve—that any economic slowdown will be met with robust monetary easing. This must work in tandem with targeted fiscal support from governments.

Ultimately, the difference between an event-driven soft landing and a hard-landing recession may hinge on how coordinated, timely, and credible the diplomatic and economic policy responses prove to be. That said, it's also worth keeping some perspective. As Nobel laureate Paul Samuelson famously quipped, "Economists have predicted nine of the last five recessions."

Chart of the week: US bear markets and recoveries since the 1800s

Source: Goldman Sachs Global  Investment Research as of April 10, 2025. For illustrative purposes only.

 

References

1.Bloomberg index: WORLD Index
2.Bloomberg index: VIX INDEX, MOVE INDEX
3.Bloomberg as of April 10, 2025.
4.BLOOMBERG FUNCTION: WIRP
5.US HY represented by the ICE BofA US Cash Pay High Yield Index (J0A0) and  US IG represented by the  ICE BofA US Corporate Index (C0A0)
6.EM flow dynamic – Scrambling for a foothold, standard chartered as of April 11, 2025.
7.The 2025 Tariff Shock , JP Morgan, as of April 7, 2025.
8.Different Bear Markets, Goldman Sachs as of April 10, 2025

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co. are as of April 14, 2025, and may change without notice. All data figures are from Bloomberg, as of April 14, 2025, unless otherwise stated.

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