What's on the Horizon?
In 2022, the stock and bond markets have experienced historical turbulence.
Wednesday, 5/26, marked the 100th trading day of 2022, with the Dow Jones Industrial Average and S&P 500 on track for their worst start since 1970. Leading into this week, the S&P 500 has been down for seven consecutive weeks, a streak only matched 3 other times in history. The bond market has also struggled with its worst start since 1842.
So where do we go from here? What are our advisors sharing in conversations with clients? What’s on the horizon? To answer that, we’ll unpack the following questions:
What are the economic headwinds?
What are the Economic Tailwinds?
How do we make sense of it all?
As a spoiler, I’ll note that we currently don’t have a crystal ball in our office. It ran out of batteries and the supply chain issues make getting it back up and running challenging. But we do have history and logic on our side, which is significant.
What are the economic headwinds?
Inflation
The price of goods and services has certainly increased. I’m sure you’ve felt it at the grocery store and gas pump, among other places. The rising costs force companies to spend more on production and transportation, which results in a higher cost to you. Inflation occurs when too many dollars are chasing too few goods, which Austin dives into further here. As long as demand is greater than supply, inflation will continue.
Rising INTEREST rates
How do we curb inflation? One way is through the Federal Reserve tightening the economy by raising interest rates and selling assets on their balance sheet. They have already raised rates twice this year, with more on the horizon. While this should help with the inflation problem, it will also make it tougher for individuals and companies to borrow money. Last, rising interest rates negatively impact bond prices that have a lower rate. This has been the culprit for the harsh bond market.
Geopolitical uncertainty
When Russia invaded Ukraine earlier this year, it opened up a wide range of outcomes that threw the stock market for a loop. While war has historically been positive for the market, uncertainty hasn’t been. Now that we are a couple of months removed from the initial move, it’s more probable that this is an isolated event and not the start of something more. The biggest headwind at this point is the de-globalization that has occurred as a result of the conflict and other supply chain issues. After years and years of outsourcing the production of goods and materials, companies are beginning to return to the U.S. While it will be more expensive in the near term, it will allow for more strength and flexibility in the future.
Investor fear and uncertainty
As Barry says, “Markets move negatively on rumors and positively on facts.” The headwinds we discussed above, while legitimate, are moving the market negatively due to what could happen instead of what is happening. With some investors running for the hills because of the downturn, the demand for stocks weakened, driving prices lower.
What are the economic tailwinds?
Earnings Reports
As of 5/20, 77% of S&P 500 companies have reported a positive earnings per share surprise, and 73% of S&P 500 companies have reported a positive revenue surprise in the first quarter of 2022. In layman’s terms, most companies have continued to outperform in a difficult environment! On average, companies that surprised in earnings per share to the upside have seen a negative stock price reaction, which is unusual. Most companies have continued to do their job of making money for their stakeholders, but have simply encountered a rainstorm of fear and uncertainty in the stock market.
Job market
According to Peter Mallouk, there are now two job openings for every unemployed person. Wage growth is up 6% from last April. Most importantly, if you talk to a small business owner, you’ll learn that finding employees is the most challenging part of their job right now. Here in Brentwood, we’ve seen multiple shops alter their hours due to a lack of employees. Throughout history, a strong job market and a recession don’t generally intertwine.
Housing Market
While there has been a breather in some areas of the housing market due to an increase in interest rates, there is still a shortage of 3.8 million homes to meet the current demand. There are multiple potential buyers for every home on the market. But you’re probably thinking, isn’t this the same as 2008? From our perspective, the great recession began a result of bad loans made to individuals and businesses that couldn’t afford their properties. The current environment has been created by low borrowing costs and an increase in the amount of money in the U.S. economy, which is 40% more than in January 2020. Much different and healthier.
How do we make sense of it all?
Investors and economists who are smart will tell you that it’s not what you know that affects the stock market, but what you don’t know. We believe all of the current information is baked into the current value of stocks and bonds, but we don’t know what’s on the horizon. Who could have predicted a worldwide pandemic in 2020? That’s why we take the initiative to invest in quality stocks and bonds for our clients and encourage them to take a long-term approach. Let’s take a look at some data to see if that approach checks out.
market bouncebacks
Stocks are generally up significantly 60 days after reaching the bottom of a down turn, with the S&P 500 up almost 20% on average. News is still negative during this time period, which makes the recovery hard to recognize. The market is even stronger in the 5-year period after the recession. See the chart below from Capital Group that goes into more detail.
interest rate increases
As we noted above, an increase in interest rates has made it more expensive for individuals and companies to borrow money, but there’s a purpose behind it. The U.S. central bank is using the lever to help curb inflation. While that might be painful in the short term for investors, it should make our economy healthier in the long term. In fact, the stock market tends to appreciate rate hikes over history, with the S&P 500 finishing positive 100% of the time one year out from an initial rate hike.
The power of staying invested
We know the power of staying invested for a long period of time, but most of that success is based on the few days that the market hits a home run. Being invested on those days increases your total return while being out of the market significantly hurts it. We don’t know when those days will come, but we would encourage investors to purchase quality companies and stay invested, even in a down market. See another visual below from Capital Group that highlights this point.
Final thoughts
Our perspective on the current market is that the headwinds have been accounted for and positive news should lift it higher. Brian Wesbury, Chief Economist at First Trust and an economist we like to follow, predicted that the S&P 500 finishes the year near 4,900. That’s significantly higher than at the time of this article.
With that being said, we don’t know if that will happen. If anyone tells you they do know, they’re bluffing or egotistical. We can’t control issues with the supply chain, inflation, interest rates, or war, but we can control our mindset to own good companies for the long haul and trust the U.S. economy’s resilience. Downturns are common in the stock market. Don’t let fear or uncertainty drive you away from what history and logic show us to be true.