An equity bear market begins

Last week’s action, particularly in Japan where the Nikkei 225 Index fell 15% in less than a month and 9% of that in just two days suggests the bull is over and the bear is now in charge.

Bear markets surprise the vast majority of investors, who are instilled with a mixture of peer pressure, complacency, and speculation.

These conditions can continue for some time, lulling everyone into an increasingly false sense of security. But there is lots to go wrong. There are government debt traps that require higher not lower bond yields to fund. Being the consequence of government budget deficits, inflation is not going away but will persist, putting a floor under central bank attempts to suppress interest rates. And commercial bank balance sheets are highly leveraged while lending risk is increasing, typical at the top of the bank credit cycle. Credit is the lifeblood of markets, and any restriction of bank credit is bearish. But the most important factor is the stretched valuation of equities compared with bonds.