The US officially entered bear market territory in June after a 20% fall from its January peak. Cue instant speculation around the globe over whether it’s the start of a longer downturn or a mere blip before a stock market recovery.
So, which one is it? As we head into the second half of the year will the stock market recover or should we batten down the hatches and get ready for more falls?
Before we ask when the stock market will recover, it’s useful to reflect on how we got here and remind ourselves of a few things.
First, volatility (market ups and downs) in all its forms is a normal part of market life. It may be that it’s the first time new investors have experienced a fall from grace so it’s worth reiterating that this is nothing new.
Ups and downs come in as many sizes as McDonald’s drinks and are the price we pay for the hopeful outperformance of company shares over cash in the long term.
Two years of soaring outperformance from US tech might have fooled us into thinking indices only go one way. No-one likes to see their shares fall but a reality check might not be such a bad thing before valuations become completely detached from earnings.
But there’s more to it than investors selling the pandemic tech theme.
📊 Investing in tech stocks
Unfortunately, stocks are getting hit from all angles at the moment. And the drinks cabinet behind this year’s rather unpleasant market cocktail includes bottles from far and wide.
China has had to shutter whole cities again after Covid threatened to make a comeback. Shenzhen, a major finance and tech hub containing more than 17.5m people, became a ghost town overnight as the country’s zero-Covid policy took effect.
Given China’s importance when it comes to manufacturing and global supply chains, as well its demand for commodities that power its vast plants, the halt in its recovery has been felt worldwide.
China’s persistent lock-downs are a double-whammy for companies that were already scrambling to catch up with a post-pandemic demand surge. The problem was they cut capacity hard during the pandemic, and have found it difficult to ramp back up in line with demand.
All this has led to a surge in inflation this year, which has poured more fuel on cost fires across the world. And gripped by a fear of runaway inflation and all the damage that might do, central bankers like J. Powell have been slamming on the brakes and ramping interest rates.
These higher interest rate trajectories designed to keep inflation in check are also increasing the number analysts use to get a picture of what firms’ future earnings are worth paying for now. Dividing by a bigger number gives a lower outcome, which means investors start to expect less particularly from growth companies whose true value is still down the road.
The result is that highly-valued tech has taken a beating and, given the biggest names made up around 25% of the US market earlier this year, their demise took the crowd down too.
But we might be about to do a full circle. The markets now seem to believe that the action taken by Powell and his Federal Reserve bankers will push the US economy into a recession. In fact plenty of commentators already think the US is in a recession.
This might all be happening at the same time supply chains start to hum again. So we could be facing a period of weaker demand driven by a recession and a ramping supply.
As usual, markets are forward thinking and to a large part have discounted a lot of these fears into stock prices. What the market doesn’t yet know is the impact that surging costs and a possible weaker demand outlook will prompt company managements to say about their profit forecasts for this year.
So while we have had the first stage of a bear market, which is a fall in share prices reflecting a deterioration in upcoming profits, the current guessing game going on amongst commentators is the extent to which profits are going to fall for the rest of the year.
We will know more when US companies report their second quarter earnings and update the market as to their current expectations for the rest of the year.
🛒 Inflation and the stock market
It’s natural to look at history and try to ctrl+v what happened in previous bear markets onto what’s happening now. Where we don’t have the answers, we always try to create patterns for ourselves or look for existing ones to make us feel better.
It’s not the best use of our time though because of the incredibly wide range of factors affecting markets before, during and after previous crashes.
So, if you’re looking for a stock market recovery time chart that you just want to follow like a Jamie Oliver 30-minute meal, you’re not going to find it. That’s your fear talking, not your composure.
While history doesn’t repeat itself though, it often rhymes and there are some broad lessons that come out of bear market scenarios.
Past performance is not a reliable indicator of future returns.
Source: FE, as at 1 July June 2022. Basis: bid-bid in local currency terms with income reinvested.
According to APNews, bear markets since World War II have taken an average of 13 months to go from peak to trough, whereas the average time for the stock market to recover stands at 27 months.
That might sound like a painful journey down and back to breakeven but zoom out and there’s reason to stay a bit more positive.
Going back to 1929, Hartford Funds says the average length of a bear market is 289 days, or about 9.6 months. That's significantly shorter than the average length of a bull market, at 991 days or 2.7 years.
What’s more, while stocks lose 36% on average in a bear market, when the tides turn, they gain an average of 114% during a bull market.
The point here is it’s a waste of time trying to predict these things with any great precision.
Instead, as long-term investors, we need to focus on just that, the long term, and do our best to not give into short-term doom and gloom.
No-one rings a bell at the top or the bottom of the market. And there’s a reason we should actually be ok with that uncertainty. It lets us examine companies on the ground and assess whether they are being treated fairly by the rest of the market.
If we all had an unfailing Magic 8 Ball and could predict exactly when stock markets will recover, what the trajectory will look like and which stocks will perform well, and all of that certainty would create an entirely efficient market. No mispricings, no chances to buy stocks for less than they’re worth and no point in active stock picking.
As uncomfortable as it can be, uncertainty creates opportunity for us as investors.
So, while we’re all looking for the trigger that moves us up again, our time is better spent on the companies we think are being unfairly tarnished by the broader malaise.
History tells us this period will pass and it’s no use holding your breath just to be able to give a sigh of relief when stocks have recovered. Maybe it’s a useful time to reflect on some high valuations in your portfolio over the past few years.
Were they warranted or did you follow the hype crowd? Whatever you use this time for, make sure it helps you become a better investor with a better portfolio for the long term.
It’s interesting to reflect on the recovery scenarios touted during the pandemic. The hopeful V-shape became a U-shape, followed by a possible W-shape and the confusing K-shape. We’re still not really sure what that one signified.
The alphabet soup of options grew by the day.
Really, what it meant was that anything could happen. But, when you put them all out beforehand you can’t help but get one right and pat yourself on the back. A broken clock and all that.
So, while it’s pretty futile to predict any technical aspect of an eventual recovery, there are some broader strokes that might help get us there.
Few would argue that an end (or as much as is possible) of Covid would give markets the thumbs up. China’s relaxation of travel quarantine requirements gave the country’s stock markets a boost last week, it’s easy to see a final goodbye doing the same for global markets too.
Importantly, any positivity would undoubtedly reflect the larger picture of a world without Covid. That might seem obvious but simply putting the virus behind us doesn’t immediately resolve stunted supply chains, firms put out of business over the pandemic and GDP growth worries already here.
What would lessen global concerns as well would be an end to the war in Ukraine. Again though, ending the conflict wouldn’t simply press the reset button. Russia’s position on the global stage will be assessed among the international community and commodity-heavy Ukraine will need billions of dollars in aid to rebuild.
There are no off-the-shelf solutions here.
Specifically on economic issues, investors want to see inflation come down and interest rates held steady.
Realistically, if governments get a handle on both, markets could respond well initially.
If inflation begins to subside and rates were to come back down it would decrease the discount rate and up valuations, that’s just maths.
When it comes to rebuilding investor confidence though, the turning point will probably be when the market decides valuations are unreasonably cheap, given the obstacles the market faces. Problems don’t necessarily need to evaporate, markets just need to feel that the risks they present are overwhelmingly represented in share prices.
In this sense it’s a balancing act. Remarkably similar to that old risk vs reward tenet we tend to natter on about.
Given it’s a nigh-on impossible task to predict if and when any of this would play out, it makes the case for investing regularly throughout it. Waiting on the sidelines until it all looks clearer might end up with you missing the turnaround altogether.
After a lengthy period of record-low interest rates, it’s likely a lot of investors are equity heavy. After all, with minuscule returns on cash and bonds, the natural course of action for many will have been to adopt a bit more risk and invest in dividend-paying stocks for income.
What this means now is that we’re probably less diversified in terms of assets than we would be under normal market conditions and healthy rates of interest and inflation.
So, starting with this in mind, what is to be done?
Well, there are three key ideas here.
First, and this might not be a popular one, is to make sure your portfolio is set up to tackle the tough times before they arrive. I know, it feels like an ‘I told you so’ but it isn’t.
Objectively, investors who came into 2022 with a healthy scepticism of seemingly lofty valuations, due attention to downside risk in their portfolios and an acknowledgement that US tech isn’t the only game in town, will have been punished less.
That sounds like hindsight talking but that’s the thing, we should always have that objective view represented in our holdings. Whether a downturn comes tomorrow or in five years is irrelevant, we can’t just set course for the moon and expect no turbulence.
And even if it is hindsight, it's always important to learn lessons to continue to improve as an investor. Every day’s a school day, even for the best investors out there.
Second, and maybe more practical now, is to reassess the investment case for the companies we hold. Has the story changed? Is their long-term value still there? Has management crumbled under the Covid pressure or has it steered the ship like a champ?
Lift the bonnet and see what’s still worthy of a place in your portfolio and, crucially, what’s missing. The best time to diversify was five years ago, the second best time is today. Sectors, asset classes, geographies, make sure they’re well represented and remind yourself it’s about having a portfolio that can roll with the punches, whatever happens.
Last, look beyond trying to protect the now and seek opportunities that will reflect good value in the future. That might mean buying more of a company that’s suddenly gone on sale.
Or it might mean revisiting that watchlist and seeing which firms have become unloved given the backdrop. As the environment changes, the mood might too so it could be worth picking up those shares while they’re out of favour.
⚖️ Investment risk
First of all, don’t panic. Understand that these periods will happen. Make sure your companies are well capitalised, have margins that can take a hit if it comes to it and aren’t dependent on the overall picture to do well.
Firms in charge of their own destiny don’t care about what goes on the world, they just keep doing what they’re good at and keep their head down.
You might notice these are just good characteristics whatever is happening. In this sense, good investing criteria don’t change during bear markets, they’re heightened. So keep the quality high and don’t be tempted to try to find excessive risk just because you think the returns might be big.
That can feel like the right thing to do when the charts turn red but avoid focusing on the returns needed to recover a stock market loss. Like a gambler chasing their losses, it never ends well. Let time do the work and do your part for never sacrificing the quality of the companies you hold.
Selling at times of stress and planning to jump back in at the bottom is a bit like swapping queues in the supermarket. You’ll join one, only to see the other move quicker.
In both instances, the best course of action is often just staying put.
A big reason here is that you can still amass dividends while you’re invested. If you’re on the side lines you can’t. So the longer you stay out of the market waiting for the sweet spot, the more dividend income you’re missing out on.
Staying invested means you don’t have the pressure to time that leap back in perfectly. And ask anyone with money in the market over the past 20 years. That’s a pretty impossible task anyway.
Staying investing with a diversified portfolio also means you don’t need to make any big bets on which sectors or geographies will recover first. It’s all about preparation, never rash reaction.
🤔 How to choose stocks
When does a fall become a dip? If you rolled your eyes we don’t blame you but hear us out. When a graph goes south there’s no telling whether it will bounce back or keep heading down. What makes it a dip is enough hindsight to look back and say ‘Ah, should have bought that.’
Except, at the time it wasn’t a dip, was it?
OK, lesson over. The point is the question of buying the dip comes with a dollop of unbridled opportunism or a case of the ‘shoulda, woulda, coulda’s’.
If you really want to know whether a fall is a buying opportunity, look to the form beneath the price. Is it still recognisable? Is it still a proposition you like, with characteristics that make it money? And, importantly, is its valuation now more attractive compared to its future prospects?
Buying a firm with an achingly cheap price to earnings (P/E) ratio only tells you it’s cheap, not whether it’s good value. Cheap can get cheaper all the way to zero if the firm is just rubbish.
So before you pounce on the buy button, look through the market and actually assess the business first.
Linked to what we’ve just said, you only need to think about selling if the intrinsic narrative behind a company has changed. That doesn’t mean chucking anything out whose share price has faltered, chances are you’ll have a few of those by now.
But try to look beyond the share price to the business underneath. What is useful right now is to look at how management has dealt with the pandemic, supply chain challenges and a high inflation environment. It’s been a tough few years but a great time for investors to see exactly what the C-suite is made of.
As our chart above shows, the current drawdown in the S&P 500 still has some way to go if it’s to challenge the worst bear markets in history.
The truth is, we just don’t know if it will or not and we have to be objective about that. A string of solutions might end the nerves tomorrow or there may be even more bad news to contend with. We just don’t know.
What should be of comfort for investors though, is the market’s ability to create value overall over time. Zoom out on the full chart of the stock market since inception and major negative impacts start to look like little blips in a much more pronounced journey up the page.
Don’t become so obsessed with the here and now that you forget the bigger picture. Like a driver only looking at the end of the bonnet, you’ll make sharp, jerky movements. Look to the horizon and the ride will feel a lot smoother.
Hopefully it’s clear by now how useless it is to say with any certainty just what the rest of 2022 will look like. There will be some key things to keep an eye on though.
We’ve created one of the UK’s leading stock trading apps to help everyone build their wealth over the long term. Join over 1 million users that have chosen Freetrade for their general investment account, investment ISA or personal pension.
Important Information
This should not be read as personal investment advice and individual investors should make their own decisions or seek independent advice.
When you invest, your capital is at risk. The value of your portfolio, and any income you receive, can go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future results.
Eligibility to invest into an ISA and the value of tax savings depends on personal circumstances and all tax rules may change.
Freetrade is a trading name of Freetrade Limited, which is a member firm of the London Stock Exchange and is authorised and regulated by the Financial Conduct Authority. Registered in England and Wales (no. 09797821).
From 11 April, the FX fee charged when trading stocks priced in USD or EUR will change to 0.99% on our Basic plan, 0.59% on our Standard plan, and 0.39% on our Plus plan.
From May, monthly subscription fees will change to £5.99 per month for our Standard plan and £11.99 per month for our Plus plan.
Accounts
Benefits
Accounts
Benefits
Everything in Basic, plus:
Accounts
Benefits
Everything in Standard, plus:
