U.S. stocks have recovered some ground lost in 2022’s bear market.
Yet a volatile equity market environment persists in 2023.
Stocks continue to face headwinds as a slower economy could create fundamental challenges for U.S. companies in the months ahead.
U.S. stocks, as measured by the benchmark S&P 500 index, moved in and out of “bear market” territory repeatedly in 2022, reaching its low point in September. What is a bear market? A bear market is defined as a decline that exceeds 20% of the peak value of the index. The technology-heavy NASDAQ Composite Index (which includes about 3,000 common equities) and the Russell 2000 Index of small-cap stocks also experienced bear markets in 2022. And the U.S. was not alone. For much of 2022, stocks worldwide were down significantly as well. Since that time, stocks recovered some of the ground lost earlier, but capital markets remain volatile. A key question is whether the markets can sustain an upward trend, or if further declines could occur in 2023.
Stock market downturns occur periodically, and for various reasons. Sometimes the changes are related to excessive market valuations after an extended bull market. In other cases, they may be due to external events which overwhelm other fundamental factors that traditionally drive stock market performance.
“Keep in mind that we’re likely to experience market ups and downs regardless, and over time, markets have shown an ability to recover.”
Rob Haworth, senior investment strategist, U.S. Bank Wealth Management
“The market’s downturn in 2022 can be attributed to the rising level of uncertainty for investors,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. Three key events contributed to the environment, including persistently high inflation, a significant change of monetary policy by the Federal Reserve and the economic fallout from Russia’s invasion of Ukraine. The benchmark S&P 500 ended 2022 down more than 18% (total return).
Four bear markets have occurred in the U.S. stock market in the 21st century. You’ll note that the level of decline in the most recent bear market cycle is not as dramatic as the previous three.
The bear market of 2000 to 2002 was attributed primarily to the bursting of a stock market “bubble” in prices for technology stocks, particularly some early-stage dot-com companies. The 2007 to 2009 bear market was driven in large part by a collapse in home prices. In February and March 2020, the onset of the COVID-19 pandemic confronted investors with significant uncertainty about its economic ramifications, resulting in a short-lived downturn.
“In 2022, we saw a massive change in sentiment,” says Haworth. The persistent nature of elevated inflation appeared to cause investor anxiety. Higher inflation was a result of demand for goods and services outpacing supply. Haworth notes that despite policy moves by the Federal Reserve (Fed) to slow economic growth, higher inflation endured.
Over time, inflation numbers improved. The Consumer Price Index (CPI), the most cited measure of inflation, peaked at 9.1% over the 12-month period ending in June 2022. By February 2023, that figure dipped to 6.0%. While that represents favorable progress, inflation remains far above the Fed’s target long-term rate of 2%.
To combat the inflation threat, the Fed in early 2022 shifted its monetary policy with the goal of slowing the economy as a way to temper inflation. The Fed’s challenge is to accomplish its inflation-fighting goal without pushing the nation into a recession. Nevertheless, the economy slowed considerably in 2022. Annualized GDP grew by just 2.1% in 2022, compared to a 5.9% growth rate in 2021.1 Despite the Fed’s efforts to pump the brakes on the economy, job growth remains solid. Non-farm payrolls grew by an average of 343,000 jobs per month in the six-month period ending in February 2023. However, the pace of growth, while still favorable, slowed in recent months.2
“Payrolls are still growing, but the bulk of that growth is in the leisure and retail sectors,” says Haworth. “In addition, wage growth is slowing, which is a critical area of focus for the Fed as it tries to slow the inflation rate.” The primary threat to the economy may be the Fed’s drive to reduce inflation. Despite raising the Fed Funds rate by 4.50% between March 2022 and February 2023, inflation numbers remain elevated. While Haworth anticipates more Fed rate hike activity, it’s notable that to this point, a recession has been avoided and the labor market remains strong.
However, a spate of unanticipated regional bank failures occurred in March 2023, potentially related to the higher interest rate environment. This contributed to investor concerns. “The market’s recovery beginning in the fall of 2022 was due in large part to improved investor sentiment,” says Haworth. “Reports of sizable banks disclosing major issues damaged that positive sentiment, but we’ll have to see how that issue plays out over time.”
Stock market volatility was a constant throughout 2022 and continues to be an obvious feature of capital market dynamics so far this year.
An additional concern going forward will be market fundamentals, such as corporate revenue and earnings. “Given expectations for a slower economy, earnings (the profits companies report) are likely to come down,” says Haworth. “Any market rallies we’ve seen in recent months are not driven by actual earnings, but by positive investor sentiment. Ultimately earnings will need to be the deciding factor for the direction of the market.” Haworth anticipates that an earnings “reset”, reflecting stable or declining corporate profits, needs to play out before the market is positioned for a sustained rally.
Eric Freedman, chief investment officer at U.S. Bank Wealth Management, says it’s important to maintain an appropriate perspective about the environment. He cautions that markets are likely to continue to be volatile. Nevertheless, he urges investors to maintain a long-term perspective. “Timing the markets and trying to be precise on when to be in and when to be out is challenging,” says Freedman. “Markets will do things at the exact opposite time you expect them to.”
What are the critical factors at play that could impact the timing of a stock market recovery?
Frequent market corrections are a normal event. “Keep in mind that we’re likely to experience market ups and downs regardless, and over time, markets have shown an ability to recover,” says Haworth. Market volatility can be expected to persist given the range of issues that contribute to the market’s near-term uncertainty. “While we may see a more favorable environment develop down the road, the market still faces many challenges given the current economic underpinnings,” says Haworth.
Freedman emphasizes that having a plan in place that helps inform your investment decision-making is critical, particularly in times like these. “That’s the foundation of investing,” says Freedman.
As the stock market faces continued volatility in 2023, Haworth says investors shouldn’t expect the sudden appearance of an “all-clear” sign that market risks have subsided. “If you have cash on the sidelines, you should consider putting it to work in the market in a systematic way, such as dollar-cost averaging over a series of months.” For those with equity exposure, Haworth says investors may consider putting more money to work in infrastructure investments and real assets. “These tend to have more defensive characteristics during volatile times and also generate cash flow through competitive dividend payouts.”
Check in with a wealth planning professional to make sure you’re comfortable with your current investments and that your portfolio is structured in a manner consistent with your long-term financial goals.
Don’t let market volatility and an uncertain economic outlook derail your disciplined investing strategy.
Rather than trying to time the market, consider more time in the market with a buy-and-hold strategy.