The market has weakened over the last few days based on two main uncertainties. This market commentary should provide some perspective during market corrections like we are experiencing right now.
It is interesting that the market historically goes up 80% of the time, but we tend to forget, this also means the market goes down 20% of the time. It is how we react during times of uncertainty that has the most significant impact on our longer-term performance. It has been said that human beings make lousy investors. This is because it is hard to ignore the heart pain felt during times like the present. This causes emotional decisions that often manifest regret in time. It becomes a battle over heart and mind. Even though you know the market always recovers, and often in a relatively short period of time, the emotions are hard to put aside. Hopefully this commentary will help.
The market always overdoes it during times like this which creates the typical V-bottom, when the recovery can nearly be as dramatic as the weakness itself. There is a lot of evidence that a bottom is near. Indicators we watch suggest there is a tremendous amount of pessimism, which usually means we are about to reach the turning point. Below is a chart of the market during 2020 when Coronavirus put us into a short-term tailspin. You will see the sharp V-bottom that typically occurs right at the time investors are the most concerned, and then the rally begins. Those that succumb to the emotions of the time may not ever recover. You need to endure some near-term risk so that you are there when the market turns. As I have already mentioned, the initial recovery that forms the V-bottom is often as violent to the upside as was the selling during the uncertainty.
The two drivers of the current fear are interest rate hikes and the Russia/Ukraine geopolitical issue. Let’s start with the uncertainty caused by Fed tightening. Higher interest rates and inflation do not have a major impact on the markets until they rise to the level that curtails economic activity. Interest rates are still very low by historical standards. I started in this business in 1982 when mortgage and CD rates were in the high teens. The Fed raised interest rates 8 times from 2016-2018 to a higher level than now, but the market still did well after the initial reaction to the policy shift. The chart below shows the minus 10.3% start to 2016, but the S&P500 finished the year up 12%.
Now let’s discuss the Russia/Ukraine geopolitical issue. The market simply does not like uncertainty, but geopolitical events usually create a relatively shallow pullback and recoveries are historically quite fast. For example, even during Pearl Harbor the market went down about 3% and recovered that within a week. The market recovered just two days after the assassination of JFK. I think you would agree that this event does not compare to either of these examples.
There has been a major rotation out of growth stocks and into stocks that are considered less volatile. We also believe this rotation is near the end. There are now many value stocks with earnings growth in the single digits, that are trading at the same valuation as growth stocks with earnings growth of over 20% a year. Again, the market always overdoes it, so if you are a longer-term growth investor, stay the course. Quality growth stocks are likely to recover even faster than the market itself.
In conclusion, we feel this is a normal market correction and recovery will come with patience. The market always overdoes it to the downside which creates a dramatic turn off the bottom. After the initial downturn which created the current low on January 24th, we saw the typical 50% retracement which gets back half the losses. The next step is usually a test of the recent bottom and so far, we have held above that level. Whether the market low is already in the charts or not, we encourage our clients to avoid decisions based on the emotions of the moment and believe patience will be reward in time. Enjoy those and the things you love and try to look six months or more down the road. The underlying fundamentals always win, and earning growth is sound and economic growth is still above trend.