A bear market is officially here thanks largely to stubbornly high inflation. For many of us, it has probably felt like a bear market for a while now, but the S&P 500 Index didn’t close more than 20% below its January 3 record high until Monday. Tech stocks are down a lot more—the Nasdaq Composite is more than 32% below its November 2021 record high.
It’s hard to find a silver lining in inflation over 8%, but here’s the good news. Goods inflation came down quite a bit, which is likely to continue. Also keep in mind that the Federal Reserve’s (Fed) preferred inflation measure, the core personal consumption expenditure index (PCE) is just under 5% (the next core PCE report is due out on June 30). The PCE inflation reading factors in product substitutions, making it a better reflection of how consumers are actually coping in this tough environment.
For those worried the Fed may be overly aggressive in its fight against inflation, consider the market has done a lot of work already. Home price appreciation has slowed on higher mortgage rates. Lower stock values will likely slow spending. Margin balances have fallen. Wage increases have leveled off as layoff announcements and pulled job openings have started to hit the newswires. The cost of credit has increased based on investment-grade and high-yield corporate bond spreads. Financial conditions are already tightening early in the Fed’s campaign. This is all actually good news, since these factors suggest the Fed may pause its rate hiking campaign in the fall.
Keep in mind a good part of the inflation problem is on the supply side (COVID-19, supply chain disruptions, Russian oil sanctions), so there’s only so much the Fed can do by curbing demand. While some of these supply issues may take many months to resolve, we believe they will be resolved before long. While oil prices are a wildcard, we are confident that a sizable piece of the inflation problem will get better in the months ahead and that patient investors will be rewarded.
So now that the bear market is here, what should investors expect? Stocks are near their average decline in a bear market without a recession at about 24%, potentially introducing an attractive risk-reward trade-off for stock buyers here. The job market and consumer balance sheets simply look too strong for a recession to come soon. Monday’s trading session also got us closer to the type of capitulation and indiscriminate selling that has marked prior major lows. The VIX measure of implied stock market volatility rose above 35 on Monday, close to the 40 level that has accompanied other major lows and suggesting an eventual market bottom may not be far off.
Here’s another encouraging statistic to help investors stay the course. After the S&P 500 enters a bear market, the median 12-month gain has been 24% with advances in seven of the past 10 instances back to 1957 (only 1973 and 2008 saw big declines). Even better, the average historical 12-month gain off a midterm election year low is over 30%.
In closing, don’t forget that lower stock prices can lead to attractive valuations, improving prospects for future returns. It’s tempting to sell, but history tells us that after big declines it can be the wrong move.
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*Content and Research from LPL Financial*
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.