So far this year, the markets have had an unsettling start. Investors are wondering:
- Why are the markets dropping?
- When will we hit the bottom?
- Should I wait on the sidelines until things get better?
- Should I buy on the dip?
- Will we see a v-shaped recovery?
- Is there anything else I should be doing?
Let me address each of these valid questions individually.
Why Are the Markets Dropping?
The S&P 500 is down almost 18% since it’s January high. A bear market typically describes a condition in which securities prices fall 20% or more, so the current market is close to reaching that point. Some of the reasons for the drop include:
- Uncertainty around The Federal Reserve’s changes to monetary policy. The markets, and investors, hate uncertainty. Initially, there was uncertainty around what the Fed was going to do to combat inflation. Now there’s uncertainty around how the economy will adjust to interest rate hikes.
- Inflation. Part of the reason the Fed is adjusting interest rates is because of scorching inflation. This is likely the main driver of the market drop.
- Poor quarterly corporate earnings. The Q1 earnings season has just concluded and while some companies are reporting decent earnings compared to the previous quarter, many are projecting a slowdown due to supply chain issues, interest rates and the continued impact of COVID.
- Political uncertainty with midterm elections. While the midterm elections aren’t until November, the markets typically get volatile in election years.
- Global uncertainty, particularly because of the Russia Ukraine war. Uncertainty remains around what will happen to the European countries that have been dependent on Russian goods, like oil.
A Couple of Facts About Bear Markets
The stock market is cyclical, and bear markets do happen. Over the past 100 years, there’s been a bear market every 3.6 years – although since WWII, they’ve been less frequent happening every 5.4 years. While scary, bear markets tend to be short lived. The average length is 289 days.
One of the questions I’m frequently asked is: If we know a bear market is approaching, why not just wait it out on the sidelines? Well, the reason is we don’t know when the bear market is approaching. Over the last five years, financial experts and economists have warned of a bear market that never came. If an investor had listened to their predictions, they would’ve waited on the sidelines for five years and missed out on enormous gains.
In the last 20 years, half of the S&P 500’s strongest days occurred during a bear market. Another 34% of the market’s best days took place in the first two months of a bull market – before it was clear a bull market had begun.
When Will We Hit a Bottom?
There’s not one indicator that determines a bottom is imminent, but there are some signs that a bottom is near:
- Investor Sentiment: A recent poll by the American Association of Individual Investors showed that 52.9% of investors are bearish, with only 26.9% bullish. Bottoms are typically made when most investors don’t see positivity on the horizon.
- Consumer Price Index (Inflation Data): April’s inflation numbers were released on Wednesday. While the reading was high, it was the lowest it’s been in the last 8 months. If this is the start of a downward trend on inflation, that will definitely help the markets.
- Technical Indicators: Technical indicators are showing that many stocks are not at the levels reached during the last two notable bear markets: The 2020 COVID drawdown and the Great Financial Crisis of 2008-2009. One technical indicator is when a majority of stocks fall below their 200-day moving average. This indicator compares the average stock price of a company over the past 200 days to the current stock price. When the current stock price is below that average, it’s said to be a bullish sign. Many companies’ stock prices are now under the 200 day moving average, but not enough to say that it is an overall positive indicator.
- Stock Prices: One way to measure stocks is by using a ratio called the Price to Earnings or P/E Ratio. This looks at the current price of a stock compared to its earnings, revealing how much you’d have to pay for a share of stock relative to how much revenue the company is generating. With the market drop, a lot of P/E numbers have become reasonable. But the bears point not to current P/E numbers, but the future projections – and many companies are reporting a potential slowdown in earnings.
What Should You Do: Wait on the Sidelines?
I know it seems like every time there’s a drop in the market I say, “Stick to your plan.” This can be frustrating for investors because your gut instinct is to react, but sticking to your strategy is the best course of action.
Why Timing Doesn’t Work
- You have to be right twice: First, when you hit the sidelines and second, when you come back in the game.
- You’ll miss a couple of the highest earning days.
How We Are Investing
- We still are rebalancing client’s portfolios.
- We are still looking at and adding specific sectors and investments that tend to do better during inflationary periods. But if we hit a peak inflation, we will look to cycle out of those.
- We’re also proponents of companies/sectors that are boring but dependable. They generate solid cash flow and continue to grow regardless of the direction of the economic cycle.
Should I Buy on the Dip?
Buying the market simply because it’s down – in this case for five straight weeks – is not a viable strategy. The reason goes back to why we don’t time the market: You don’t want to be catching a falling knife.
However there does seem to be a disconnect on some of the drops in stock prices versus the underlying fundamentals for the companies. Some companies were overpriced relative to the earnings they currently and are projected to bring in.
The reality is we could see more drops ahead.
Will We See A V-Shaped Recovery?
When we do hit a bottom, will we see a v-shaped recovery. A v-shaped recovery is what we saw in March 2020: Stocks dropped about 30% in March, as we were going into full lockdown, but they recovered in the blink of an eye. People didn’t have time to realize there was a big drop as we were all more focused on our health.
Focus on the Things You Can Control
- Last week, we sent out a notice to clients to upload their tax return for an analysis. We’re already seeing opportunities to save a substantial amount of money.
- Because IRA values have dropped, Roth conversions make sense right now. If you have 10 shares of stock of a company that was worth $1,000, but it’s worth $800 now, you are paying the conversion tax on $800.
- Run an analysis to ensure that your goals haven’t been impacted. We run monte carlo simulations which have thousands of potential outcomes to ensure that when drops happen, your goals won’t be impacted
It’s definitely emotionally taxing, but staying disciplined has proven to be the best outcome when we experience heavy turbulence.
Our team is always available to talk. We offer complimentary consultations, which you can book below. We’re also accepting new clients, should you need longer-term support.