“In a correction, other people’s stocks go down, in a bear market, your stocks go down.”
– Alan Abelson
“Down cycles are not fun. But they form the basis for enormous future profitability.”
– Steven A. Schwarzman
Bad. That is the only word we have to describe the markets we follow for the month of April. Every major stock market index was negative, as was the Aggregate Bond Index, which posted a negative 3.57% return last month. Commodities continued their strong uptrend with a 5.63% monthly return. The US Dollar was also strong, up 5.15%.
All data as of 05/01/2022, Source: Wells Fargo Investment Institute. [Wells Fargo Investment Institute, Inc. is a registered investment advisor and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.]
After three really phenomenal years for the stock market, here at Magellan Financial we were expecting 2022 to be a much different investing experience. Markets don’t move in one direction forever. Three years of quiet prosperity usually doesn’t lead to a fourth. Put another way, we entered 2022 fully expecting the stock market to, at some point, have a market correction of 10% or more.
What we didn’t expect a few months ago was a war in Europe, a supply chain altering COVID shutdown in China, inflation like the 1970s, or extremely aggressive interest rate hike talk (and action) from the Federal Reserve. Now here we are at the start of May with all of those factors weighing on the stock and bond markets.
Stepping back for a look at the big picture, the stock market appears to be at a bit of a crossroad. After three extremely good years for the S&P500 – briefly interrupted in March 2020 – we have a chart pattern that is referred to as a head-and-shoulders topping pattern. The expectation for such a setup is a move to lower levels.
BUT … the key word in that last sentence is EXPECTATION. There is no guarantee that, just because a chart looks like something will happen, that it actually will happen!!! Looking back to 2010 we, in fact, had a similar setup that turned higher, not lower, despite what looked and felt really, really terrible at the time. So even as the current situation resembles what happened 12 years ago, there are no guarantees the same result will happen.
With many reasons to believe the stock market can move either higher or lower, we are cautious at this moment as we wait to see how the market turns.
Market Corrections Happen
Timing is everything. When the stock market drops 10-15% over the summer then rebounds into the close of the year it feels bad. When it happens at the start of the calendar year, on the other hand, it is historical.
Speaking of history, mid-term election years are not good years for the stock market. How rough? Average (17%) peak-to-trough. The April closing lows were (13%). The positive news (and we can sure use some) is that the next year is usually a good one, averaging +32%.
The other piece of good news is that, so far, this looks like a normal stock market correction. Granted, it may not FEEL like a normal correction, but it really has been quite normal. Since WWII the average market drawdown has been 14.3%, a bit less than what happens in a mid-term election year. So while we may be in line for more pain ahead, there is nothing unusual about this correction, and it doesn’t necessarily mean 2022 is a total loss. Just as corrections can start at any given time, they can end when you least expect it.
Chart #4: Source: LPL Research, FactSet
The Economy and Sector Rotation
When thinking about the stock market we also need to consider where we are in the economic cycle. As investors, having an understanding of sector rotation tendencies can give a leg up in making decisions on where to invest as well as where we are in an economic cycle. Which leads to a simple question: where are we now?
Based on current market leadership – energy, basic materials, staples – late expansion/early correction. This suggests that the market has peaked for the time being and that the economy is still in growth mode.
An outlier sector that is doing well right now are utilities, which doesn’t line up with the cycle. This, we believe, can be explained by two factors. Utilities are interest rate sensitive because it is a capital-intensive business. Right now, interest rates are starting to increase, which normally hurts the sector. With interest rates still at economically stimulative levels, rates aren’t so damaging to this capital -intensive sector. In addition, the change from carbon-based fuel to renewables within the industry is a unique situation for the sector. These two unique factors have changed, at least for the time being, the current prospects for utilities companies.
What About Bonds and Commodities?
After an interest rate peak in the early 1980s, the bond market has gone in one direction for 40 years. For about the last decade we have been hearing that the great bull market for bonds was over. Finally, in 2022, it just may be. Chart #6 is a 20-year chart of the 10-year Treasury Bond yield. The hyper-move we have had in the rate since the start of the year has now pushed back above the downtrend line.
We are looking for two things to help determine body yield direction. First, can the rate stay high enough to remain above the downtrend line, putting an end to the bull market in bonds? Then, can the yield push above the 2018 high of 3.159% and the 2011 3.45% peak?
While we do not know the answer to these questions, we do know that whatever happens in the months that follow, there will be a spillover effect for the stock market. Higher yields could be problematic while stabilization at these levels or a drop in rates would likely be positive for the stock market.
Moving to commodities, the overall index has been doing quite well the past 18 months. With a large majority of the index being oil and related commodities, it is important to keep an eye on the individual components of the index as well. Copper, for example, is often viewed as a leading indicator for the global economy.
Copper broke out to new high levels in March, a positive for the stock market. However, a quick reversal in price has now led to what looks like a breakdown. Could this be a top for Dr. Copper? If so, that could have negative implications for the economy and the stock market..
Two things to do when managing through Market Corrections
There are times that investing feels very easy and times that it feels hard. The former tends to correlate with bull markets as the latter with bear markets or market “corrections.” Right now, we are at a moment of tough sledding. We are at a point where some of us will question what why they are investing.
We know that every bear market and market correction has been followed by new all-time highs for the stock market. We also know that this fact doesn’t lessen the pain of financial losses in poor markets.
The first, and hardest, thing we all need to do is to not let stress short-circuit your decision making. Believe us, we get it. It is hard to look at your statement and see lower numbers than you did last month, and the month before. It is hard to not remain in love with the stock that makes your phone and has been a 10-bagger for you over the past 8 years. As hard as it may be, it is important to take emotions out of money and finances.
Stock market corrections are normal. They do not feel like it when they happen, of course. Yet, every market correction –and bear market – has resolved itself to new, higher prices for the stock market. Put another way, every market correction has preceded new all-time highs.
The other important thing is to not get into the woulda, coulda, shoulda game. I woulda known the stock market would peak at the start of the year and that body yields would spike because wasn’t it completely obvious? I coulda sold stock XYZ and ABC when they were at all-time highs. I shoulda raised A LOT of cash!!!
Markets are soooo easy to navigate in retrospect. Unfortunately, we navigate the markets in real time. And what looks so plain today wasn’t so obvious a few months or years ago.
For example, maybe you’ve heard that the bond market bull market is over and that EVERYONE should have seen the turnaround coming? Great argument except … that this has been the line for at least a decade.
Similar situation for technology stocks, which have been sinking for the last year or so. Think the downturn should have been a no-brainer, obvious downturn … just like it was in 1996, and 1997, and 1998, and 1999?
Moral of the story: Markets don’t move in one direction and corrections are completely normal. Best to check your emotions at the door and not play the hindsight game.
We think it is important to remember that market corrections are when you set yourself up for future investment returns. For those who are in the accumulation phase of life you want to continue to keep investing for retirement. Lower prices allow you to purchase more shares in your IRA with the same investment dollars. For those in the distribution phase, it is important to not panic, and stick with your plan. Like past market downturns, this one will end.
Markets move in both directions, but have always moved to higher levels over time. It is important to remember this fact. So far 2022 hasn’t been a great year for investors, but that can and will change.
Right now, we feel the markets are at a crossroad. More downside is a real possibility, but not guaranteed. As a result, we are cautious but will change quickly based on how the markets perform.
On behalf of Magellan Financial we would like to thank you for taking the time out of your busy day to take in our thoughts and opinions. If you found this helpful, please forward it on to others. If you have any questions on the materials presented, would like to be added to our email list, or would like our help with your investments, we can be contacted at 610-437-5650 or via email.
Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
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Dow Jones Industrial Average: The Dow Jones Industrial Average is a price-weighted index of 30 “blue-chip” industrial U.S. stocks.
S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock’s weight in the Index proportionate to its market value.
S&P Midcap 400 Index: The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between the S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
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Russell 2000® Index: The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents
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