History suggests stocks approaching a bottom

As published in the Star Tribune 10/15/2022.

We can’t tell you exactly when the stock market will hit bottom. We can, however, offer several reasons why you should feel confident equities are further along in the bottoming process than many would lead you to believe.

Before we do, some quick reminders for every investor (and adviser) trying to make sense of where the market goes from here:

1) You’re not lucky enough to time the bottom.

2) The more times you get in and out of the market, the lower your odds of long-term success.

3) Resist the urge to declare, “This time is different.”

The last point is especially relevant during bear markets. When pessimism reigns supreme, it’s easy to be seduced by worst-case scenarios, which make for good headlines and gaudy click totals. Don’t take the bait. Instead, let history guide you toward informed decisions that put the odds in your favor.

Historically (since World War II), bear markets bottom out when the S&P 500 has fallen 30% to 35% peak-to-trough. As of this writing, the S&P was down 26% from its all-time high. Another 5.4% loss from here would mean a 30% fall from the peak. It would take a 12% drop from current levels to reach a 35% correction from the peak.

Could the S&P 500 fall more than that? Of course it could. Again, the goal is to be prudent, not perfect. As far as buying opportunities go, prices already seem attractive for anyone looking out 12-15 months. 2022 is one of only nine years ever in which the S&P 500 lost 20% or more through mid-October. Each of the last seven times this happened, stocks were positive the following calendar year with an average gain of 27%.

All of us are understandably focused on price, but the duration of this bearish cycle also matters. Bear markets not only take your money, they test your patience. At 280 days and counting, this is the longest bear cycle since 2007-09. It’s impossible to know when the momentum will change, but it’s a positive sign that cash flows into equities topped $6 billion the week of October 3.

An official “pause” in the Federal Reserve’s monetary tightening is the most obvious catalyst that would send stocks higher. It’s not unreasonable to think that could happen following the Fed’s mid-December meeting. Even if Jerome Powell announces another hike, his comments may include an outlook that the Fed anticipates no further hikes for a specified period of time.

A larger than expected decline in monthly inflation figures ranks a close second in terms of positive developments for stocks. While headline Consumer Price Index and Personal Consumption Expenditures numbers have remained stubbornly high, there are several leading indicators (shipping costs, commodity prices, new home construction) that suggest sizable drops could be coming.

Better-than-expected corporate earnings, a resolution to Russia’s war with Ukraine, U.S. midterm elections, and December seasonality (Santa Claus rally, anyone?) are other factors that could support a potential rebound in the months ahead. The S&P 500 has climbed higher in the six months following every U.S. midterm election since 1950, with an average gain of 15%.

One distinction worth pointing out is that any eventual bottom will not necessarily coincide with an immediate rally. V-shaped recoveries will be considerably more difficult with a hawkish Fed, but even if stocks linger near bear market lows for a few more months, it will not diminish their long-term returns.

The bottom may not be in yet, but investors should be prepared. It may not be far off.

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.

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