June was a tough month for the stock market! The U.S. Federal Reserve Board surprised many with a three quarter point interest rate increase – the largest increase since 1994.[i] The Fed’s move shocked investors and economists alike, sending the unprepared stock market down into official bear market territory, or a decline of 20% from the previous market high.
The stock market is a forward-looking indicator of the economy. In this case, it is meaningful because we’ve never experienced a recession in the U.S. that was not preceded by a bear market. It is important to note, however, that we have had bear markets where a recession did not manifest in the months that followed. A lot can unfold in the months to come.
The major influencing factor for us domestically is the Fed’s policy to tackle inflation. The Federal Reserve has raised the Fed Funds rate by six quarter-point increases so far this year. Rumors are the Fed may raise interest rates another two or three quarter-points in July, which would meet or exceed the Fed’s original goal to raise interest rates eight quarter-points in 2022. The direct correlation is complicated, but raising interest rates should curb inflation. Our current inflation has been attributed to supply shortages (i.e.: chips from China, commodities from Russia) in combination with strong consumer demand, supported by low unemployment, wage growth, and pandemic related money supply. Raising interest rates should make it more expensive for consumers to borrow, and should eventually slow consumer spending, as we have seen in the housing market most recently. Further, large corporations, who have essentially borrowed free money in the past decade, will now have to pay higher interest expense on loaned money. Under such circumstances, businesses should tighten their belt and rein in corporate spending, perhaps at the detriment of economic growth.
Inflation is a problem internationally also. Inflation rates in the Euro Zone, Mexico and Canada are comparable to the U.S. Additionally, inflation in the U.K., Brazil, Argentina and Turkey exceed America. Other issues that may affect whether a recession is eminent are the geopolitical issues with Russia and Ukraine, tensions with China, and nuclear developments in North Korea and Iran. However, those are wildly unpredictable.
As of mid-year, U.S. stocks suffered their biggest six-month decline since 1970. At the same time, interest rates rose, causing existing bondholders to suffer declines in bonds and stocks concurrently. The Wilshire 5000 Total Market Index, the broadest measure of U.S. stocks, was down -20.94% by mid-year. [ii] The S&P 500 Index (500 largest corporation by market cap) lost -20.58% in the first half of 2022, with 16.45% of the YTD losses coming in the second quarter.[iii] The tech-heavy Nasdaq Composite Index was down -29.51%, experiencing more compelling highs than the general market in 2021, and now greater losses in 2022.[iv] However, anyone who experienced the Dot-Com Bubble of the 2000s is welcoming of a bear market correction that mitigates future bubbles in this sector.
Internationally, the EAFE Index of companies in developed foreign economies closed the half-year mark with losses of -20.97% and Emerging Markets as measured by the EAFE EM Index recorded losses of -18.78% over the same period.[v]
Examining other investment categories, the Wilshire U.S. REIT Index, which tracks real estate, recorded a loss of -21.64% year to date. Commodities, as measured by the S&P GSCI Index, surprisingly gave up all of its 29.05% gain from the first quarter of 2022 and closed down -2.07% as of mid-year.[vi] Talk about a volatile year!
We are still awaiting the second quarter Gross Domestic Product (GDP) reading. The U.S. suffered an economic decline in the first quarter. Therefore, a consecutive decrease in Q2 could officially meet the definition of a recession. While the idea is daunting, the U.S. has recorded a recession 33 times since 1854.[vii] Although unpleasant, recessions are temporary, and each time we have pulled through and grown to new market highs.
A June 2022 study by Nobel Prize winning economist Eugene Fama, and Distinguished Professor and economist Ken French, tracked stock gains after big market declines, aggregating U.S. data from 1926 through 2021. They found that stocks historically delivered positive returns over one-year, three-year, and five-year periods following steep declines.[viii] The data reiterates that having an investment plan you can stick to in good and bad markets pays off in the end. Rebounds tend to come swiftly after steep market declines, but those who cash out on the sidelines could miss these valuable opportunities for recovery and new growth. Market downturns are never easy, but a prudent investment plan will hopefully aide you in weathering the storm for sunnier days ahead.
[vii] Bob Veres Insider Information