Until recently, Wall Street’s benchmark indexes were seemingly unstoppable. Over the last six months, the S&P 500 (SNPINDEX: ^GSPC), Nasdaq Composite (NASDAQINDEX: ^IXIC), and Dow Jones Industrial Average (DJINDICES: ^DJI) touched psychologically important plateaus of 7,000, 24,000, and 50,000, respectively.
But what a difference six weeks has made! Since the start of the Iran war on Feb. 28, the Dow and Nasdaq Composite have briefly dipped into correction territory, while the benchmark S&P 500 has stood a stone’s throw away from joining them.
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This pullback has some investors questioning whether the S&P 500’s drop will turn into a full-fledged bear market — a 20% (or greater) decline from its closing high. Based on 76 years of S&P 500 bear market data, the benchmark index would be making history if this were to happen.
If there’s a prevailing catalyst for an S&P 500 bear market, it’d be a change of course for America’s foremost financial institution, the Federal Reserve.
Since September 2024, the central bank has lowered the federal funds target rate six times. Lower interest rates make borrowing more enticing for businesses, leading to hiring, acquisitions, and an uptick in innovation.
But the Iran war is throwing a monkey wrench into the Fed’s rate-easing cycle. Iran’s closure of the Strait of Hormuz to most oil exports has sent crude oil prices skyrocketing. Consumers are feeling the pinch at the pump, while businesses are likely to see their supply chain and production costs rise. According to the Federal Reserve Bank of Cleveland’s Inflation Nowcasting tool, the trailing 12-month inflation rate is estimated to climb 85 basis points, from 2.40% in February to 3.25% in March.
If Fed Chair Jerome Powell and the other members of the Federal Open Market Committee are concerned about the rapid rise in aggregate prices, they may halt their rate-easing cycle and/or introduce the possibility of future rate hikes. This would be a potentially devastating outlook for a historically expensive stock market.
While there’s certainly a catalyst capable of sending the S&P 500 down 20% (or more), it’s statistically unlikely that the current pullback will turn into a bear market decline.
