Riding the Storm Out
Investors are aware the markets have begun the year with some volatility and may be asking questions such as, is this a precursor of what may occur throughout the rest of the year? What does history tell us about market turmoil? We will try to answer these questions and provide some further insight into what we see ahead.
Since the year 2000 the markets have dropped at least 10% in 14 out of 22 years. In the same time span only six times was the S&P 500 negative for the year and three of those times were the first three years of this time period (2000, 2001, and 2002) and another time, 2015, the market was only lower by about 1%. A major takeaway from this might be that corrections are normal and do not necessarily lead to negative returns on longer time periods. But it is also worth mentioning there are periods of time when the market is negative for a prolonged period, such as the first three years of this century. Given what we see in the markets, we feel right now we are most likely the former and not the latter – this is part of a normal market cycle and not the beginning of a prolonged downturn.
At its intraday low a couple of weeks ago, the S&P 500 was more than 12% below the all-time highs reached at the very beginning of the year. And a few days later the index closed a little more than 10% off the highs, placing it into correction territory. The tech-heavy Nasdaq at one point was more than 19% off its highs. The S&P 500 is generally used as a barometer for the broader stock market, but does not always reflect what is occurring within specific sectors. The index is now dominated by a small handful of names, most of which are associated with the tech sector. The S&P 500 now sits 6.5% lower than where it was at the beginning of the year, but the Energy sector is higher by a whopping 24% and Financials are also positive. The overall Technology sector is in line with the broader market, however many tech stocks are more than 60% lower than their highs reached last fall.
This past week brought out a great deal of volatility in some individual stock names after earnings were released. The company formerly known as Facebook, now called Meta Platforms, lost 25% of its market value in a single day. Prior to this it had been the seventh largest holding in the S&P 500. Conversely, the third largest component of the S&P 500, Amazon, gained more than 13% after releasing earnings. We generally see large price fluctuations, both positive and negative, after earnings but these abnormally large swings reflect current market sentiment and how stock prices are largely predicated upon expectations for future earnings. As earnings reports continue, we expect to see more fluctuations in stock prices. Overall earnings reported thus far have been mostly better than estimates, indicating continued growth, albeit at a little slower pace than we experienced in 2021.
State of the Economy
This year’s stock market volatility has been primarily attributed to the expectation interest rates will rise. The market has currently priced in four to five interest rate hikes by the Federal Reserve. The liquidity added by the Fed during the pandemic was needed to help the economy stay afloat and is widely viewed as a success, but it came at the expense of higher inflation since more money being was pumped into the system. Now we are paying the price for that with higher prices and soon-to-be higher interest rates. Given the shutdowns which occurred and how they could have severely crippled the economy, this may be a relatively minor price to pay. (We will reserve our commentary on the necessity of the shutdowns, but will mention there was a Johns Hopkins study released last week showing they did not work.) Our children and grandchildren will pay for this for generations to come since the national debt is significantly higher than it was prior to the pandemic and will eventually need to be repaid. On a positive note, higher interest rates and reduced liquidity from the Fed are an indication the economy is strong enough to now stand on its own without support. If there are not as many interest rate hikes as currently expected, the stock market will likely view that positively and we could see a rally. But if there are fewer than expected rate hikes it might be because of slowing economic activity, so it is a bit of a double-edged sword.
Higher inflation and slowing economic growth have led to fears of a return to stagflation similar to what was experienced in the 1970s. Thus far the economy continues to show strength, as evidenced by a continued rise in Gross Domestic Product (GDP). Another characteristic of stagflation was high unemployment. The employment report last week showed that employment remains surprisingly strong with a very low rate of unemployment and a very high level of job openings. The inability to fill open jobs is leading to higher wages, which contributes to a rise in inflation and labor shortages. These are a drag on economic growth since businesses are not operating at full capacity. If labor force participation increases and more jobs are filled, we could see GDP growing at a level closer to full potential which would be a tailwind for the stock market.
Earnings season continues in earnest over the next few weeks and so far positive earnings surprises have outpaced negative reports so we would expect earnings to provide a much needed push to the markets. Also on tap this week is the most watched measure of inflation, the Consumer Price Index (CPI) report. It is expected that inflation remains elevated but the rate of growth could be slowing. Our prediction is that inflation will slow this year but still remain at levels higher than faced over the previous two decades.
As was evidenced by some of the recent earnings reports and the divergence in performance between sectors, we continue to see a dichotomy within the stock market. We expect this continue with companies producing table and solid earnings performing best. Even though market pullbacks are a normal part of the market cycle, the recent turmoil serves as a strong reminder the market can, and will, retreat from time to time. For retirees, it is especially important to ensure you have a plan in place with multiple sources of income so you are not forced to draw upon your investments during times when markets are lower. This is also a good opportunity to ensure your portfolio is aligned with your risk tolerance and goals. If you would like to review your portfolio or want to consider strategies to navigate what may lie ahead, please give us a call to schedule your review. We continue to monitor the markets and position portfolios appropriately to weather all storms that blow our way.
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
Please contact us if you would like to review your individual financial plan or learn how the TaxSmart™ Retirement Program can help you.
Office phone # (952) 460-3260