After three straight calendar years of strong gains, investment markets have experienced heightened volatility in 2022. Investors have had to deal with a litany of concerns. Pent-up demand and easy money policies have, together with other factors, caused inflation to surge.
The Fed, aware they may have kept their foot on the pedal a bit too long, raised interest rates. They have also signaled they were prepared to raise short-term interest rates aggressively, if necessary. To all of this, add the uncertainty of the war in Ukraine and the possibility of a recession, markets were rattled. Equities, as well as fixed-income markets, resumed the slide in the first half of June.
Perspective on bear markets
In the past few days, the S&P 5001 closed with a 20% decline in 2022. A bear market, while it sounds scary and dramatic, means that equity markets have experienced a decline of 20% or more from recent highs. While unsettling to say the least, they are, unfortunately, rather common. In the last five years, there have been three bear or near-bear markets. In 2018, markets flirted with a 20% decline but recovered just a fraction away from a bear market designation. The 34% pandemic decline in March 2020 was so brief, many have forgotten it. We remember. In our work, remembering declines encourages discipline.
Over the next few days, we will likely see many media reports about the recent decline. While some might take these as a signal that an important line has been crossed and things are destined to get worse from here, this is not necessarily true.
The bear market designation is purely arbitrary, and it is not a prediction of further declines. Financial markets are discounting devices. That means that market participants take all the available information and discount them to arrive at a value. It means that the market has already attempted to “bake in” the available information.
That information, of course, can change quickly in both directions. Since 1980, the S&P 500 has experienced, on average, a 14% intra-year decline. Despite this, 32 of the 42 years had a positive return.
What happens next: Fed tightening and recessions
The Fed has been raising interest rates to fight inflation. Many believe that this means the stock market will fall during these tightening periods. It is more complicated than that. From the 1980s through the present, there have been seven rate hiking cycles. During those seven cycles, the S&P 500 produced a positive return during four of those periods and a negative return in three.
There have been many news items lately about a recession. The reasoning goes like this- as the Fed raises short-term interest rates to cool the economy, there is the possibility that they could overdo it. This could potentially push the economy into recession, further pressuring stock prices.
While this is possible, it is far less certain than the newscasts and articles might imply. Market returns during recessionary years were often mixed. Since 1945, the U.S. experienced 13 recessions. Of the 13, six of those years were positive and seven negative. In the year following recessions, 10 of the 13 were positive, with an average return of 16.9%.
Optimism or pessimism? Better yet, realism
We are certainly not dismissive of the year-to-date declines. We know it is difficult to see hard-fought gains erode. Just two years ago, we saw the crushing declines of the pandemic followed by a quick and powerful recovery. We have seen grinding losses of the Great Recession with a slower and more halting recovery.
Neither pessimism nor unrealistic optimism are solid investment strategies. Through the current decline and many others we have experienced, we know we have a job to do. It is to be stewards of wealth. It is to provide prudent guidance through the possible opportunities and inevitable difficulties that investment markets present.
A vital part of getting through periodic declines is communication. We are here and ready to help.
Sources: S&P Global, Federal Reserve, Barclays Aggregate, Wall Street Journal, JP Morgan Asset Management, and CNBC
1The S&P 500 consists of 500 stocks chosen for market size, liquidity and industry group representation. It is a market value weighted index with each stock's weight in the index proportionate to its market value.
Past performance is not indicative of future results.