The bad news in the investment markets continued for the second quarter of 2022. U.S. stocks entered true bear market territory in the middle of the quarter and finished with the worst first six months’ return since 1970. Meanwhile, bond rates rose, causing bond investors to suffer paper losses as well.
Market analysts who are widely quoted may offer various contributing factors for the selloff. But the most often-cited trigger for falling stocks is Fed policy. Fed Chair Jerome Powell has publicly stated that his biggest concern is bringing down inflation. The Fed’s policy tool for this, aggressively raising the Fed Funds Rate, is the opposite of what would raise stock prices.
A higher Fed Funds Rate drives up short-term interest rates which, in turn, reduces liquidity in the economy. Reduced liquidity depresses corporate investment and consumer borrowing. Additionally, as inflation outpaces wage increases, consumer spending is even further reduced. All of this is a reversal of a long-term trend where accommodative Fed policy provided a strong wind at the back of the investment markets.
We see bond rates going up and liquidity going down, the reverse of the conditions that began in 2008 with the economic bailout of the Great Recession and accelerated with the stimulus package following the 2020 onset of the Covid global pandemic.
The economic community seems to think that the U.S. will meet the technical definition of a recession sometime next year, but we could actually be there now. In the past, market returns have anticipated economic slowdowns with more accuracy than analysts, and market recoveries have also tended to start before the end of the slowdown – as people intuited a light at the end of the tunnel.
You would be hard-pressed to find an analyst who thinks that individual stocks, or stocks in aggregate, are actually worth 20% less than they were six months ago. In fact, profit expectations for 2022, for the companies that make up the S&P 500 index, have risen this year. Historically, in years when the S&P 500 has fallen by at least 10% in the first half, the second half has averaged a 4.3% gain.
There are no guarantees in the investment world, of course, but history suggests that market downturns represent a buying opportunity for the long-term and that markets tend to overshoot the actual underlying conditions on the upside and also on the downside. One of the reasons for a downside overshoot is that human psychology seems to be inverted when it comes to our investments. In the general marketplace, when something goes on sale, people flock to buy. But when stocks and other investments go on sale, people seem to regard it as a selling opportunity.
Negative market returns mean that investors have been flocking to sell in the first half of this year, and many of them will lock in real, permanent losses. More patient investors, however, will accept the paper losses as a temporary decline in a long-term uptrend and, if history holds, will ultimately experience a recovery and no diminishment of their portfolios’ buying power.
As we all navigate this rough market together, we at LongView remain confident that wise financial planning and thoughtful investing is a winning combination. We are here for any questions and needs that you have.
Wilshire index data: https://www.wilshire.com/indexcalculator/index.html
Russell index data: http://www.ftse.com/products/indices/russell-us
S&P index data: https://www.spglobal.com/spdji/en/indices/equity/sp-500/#overview
Nasdaq index data:
International indices: https://www.msci.com/end-of-day-data-search
Commodities index data: https://us.spindices.com/indices/commodities/sp-gsci
Treasury market rates: https://www.bloomberg.com/markets/rates-bonds