Top Questions During This Market Sell-Off
Everyone has the brainpower to make money in stocks. Not everyone has the stomach.
The news recently reported that the US stock market (measured by the S&P 500) has suffered its worst first half of the year since 1970; one of many signs of a volatile market that has stressed investors. With ongoing worries about rate hikes and a looming recession, many are wondering if there are more declines to come — certainly, as seen in this article on the business times, there are many who believe so. While nobody knows for sure what the future holds, we can look at what has happened in the past for some perspective.
Are Sharp Declines Followed by More Declines?
A reduction in stock prices is typically a reaction by investors around the world in anticipation of one or two things —
They expect the company to deliver lower profits than before and/or;
They want higher expected returns to bear the uncertainty of an investment.
However, to answer the question of whether the initial decline could be followed up by even more declines, we examine whether it has happened in the past and if so, how frequently. Using the long history of the US stock market from 1926, the chart below plots the relation between the performance of stocks over the past 100 days vs the next 100 days — a simple test of whether there is continuation in broad stock market returns.
For all periods (represented by the left chart) the probability of the market going up is relatively high at 70%. For the periods where the first 100 days suffered a sharp decline of more than -15% (right chart), the likelihood that the market goes up the following period was also surprisingly high at 62% of the time. So whilst you may hear a lot of discussion or opinions that the market is likely to go down further, the data shows that it is much less than a 50/50 chance.
Do Sharp Declines Signal Impending Recession?
Calls of an impending recession were hotly reported in the news over the past several weeks. Why? It is simply down to the disbelief that the US Federal Reserve would be unable to tame inflation without inadvertently plunging the country into a recession. Most investors assume that recessions are bad for investments. However, if we dig into the seven recessions over the past 50 years, there is more to that story.
Of the seven periods, the market produced a positive return in five of them. During two periods, the average market return was higher than the average monthly return over the full sample period shown below. The severe negative returns during the Great Financial Crisis and the collapse of the housing bubble in 2008 bring down the overall average during recessions.
When is the Best Time to Invest?
So far, for every recession that has happened in the past, the equity markets led the economy by several months, if not longer. By the time the recession was underway, equity markets would already have been rising. So if you were thinking of jumping out of the market because of the recession predictions — don’t — and if you were waiting for the recession to hit before putting more money to work into your investments — don’t either! The table below shows that equity markets had risen by substantial double digits before the worst of the economic numbers. And by the time a recession was officially declared over, you would’ve missed the boat by some margin.
It’s been quite a bumpy ride for many investors in 2022. Understanding how the market has reacted during past events can help ease some of the anxiety and provide insightful perspectives into what to do next. The top questions surrounding investments can be answered by looking at some of the information above. Staying focused, keeping your portfolios diversified, and maintaining your portfolio VaR and risk levels within tolerable boundaries will set you up for success.
For more investment insights and strategies to successfully navigate the current market situation, come and have a chat with us.
