Picture this: you are driving on the highway on a warm spring day (especially nice to imagine during this winter). The windows are down, and your favorite music is playing on the speakers. On the horizon appear some ominous-looking clouds. Your path is headed directly into them, but you need to get where you are going, so you soldier on. It shouldn’t be hard to draw parallels between this fictitious road trip and our current state of affairs in the stock market. With the steady drip of bad news, it is hard to focus on the road ahead, but hopefully, I can provide some clarity.
The most significant storm cloud at the moment is the persistent problem of inflation and the actions the Federal Reserve will be forced to undertake. As I have written about before, the Fed is tasked with keeping prices stable and people employed. A trip to the supermarket or gas pump quickly dispels any notion that they are passing the first test. Historically, when they have started a rate hiking cycle, they have never led with anything more than a 0.25% increase (we are currently at 0%). Borrowing another automotive analogy, this is like taking one’s foot off the gas and not directly pressing the brakes. Investors are reading the tea leaves (and the minutes from the Fed meetings), and expectations for an atypically aggressive 0.50% opening increase are growing. Higher interest rates cause investors to rethink their previously held beliefs about the prospects for their stocks and the economy. Still, they do not necessarily predict a bear market for stocks.
The other storm cloud we could see coming is the historical performance during midterm election years. We can guess the reasons behind this but, frankly, they don’t matter. We know that since 1950, the average pullback in a midterm year is -17.1% compared to between -11.3% and -13.1% for the other three years. Last year we saw the US stock market gain 27% with only a 5% pullback. In other words, we were due. The silver lining in this cloud? The average market return after the midterm low is 32%. Given data like this, the temptation exists to time when to get in and out using historical precedence, but it is never clear in real-time.
The rogue thunderstorm blowing into this situation is the standoff between Russia and the West by way of Ukraine. I don’t pretend to be an expert in geopolitical matters, so I won’t attempt to forecast the outcome. However, plenty of investors are taking measures to protect their portfolios from any escalation on that front, which shows in the daily price moves. This isn’t the first flare-up of hostilities, and it certainly won’t be the last. Before hitting that sell button, think about all the prior occurrences and the related outcomes.
Driving through an intense storm is never fun. You decelerate, grip the wheel a little tighter, and intensify your focus. Anyone with a driver’s license is forced to weather the occasional storm, much like anyone invested in the stock market is forced to endure these periods of volatility. It is never fun, but it is the price of admission for the long-term returns that stocks provide. Pragmatically, it is best to focus on things within your control during these times. Evaluate your spending. Rethink the risk levels in your investments. Save more. Talking to a financial advisor can help focus with an objective eye.
Author: David Rath, CFA
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