Sp500 index, fund investing - The Art of Wealth

Just when it looks like the market is recovering, poof! Something pulls it back and hinders progress. A surprisingly strong jobs report is the latest reason for stocks to suddenly struggle again. This could mean that the Federal Reserve will have to keep its aggressive interest rate hikes for an indefinite period, pulling the market down even further.

It is possible that the recent market dip is just a short break in a positive trend that has been growing since October, and maybe the poor performance this week is just a momentary correction before the market continues upwards. After all, no one can predict what will happen in the future.

Statistically, the October low is not the final low of a bear market for several reasons.

Photo: Will the falling trend continue or will we finally break through resistance?

Will the market turnaround be like previous ones?

But this way of thinking prevents a much more appropriate question: Is searching for the bottom of a bear market worth the risk and not seeing it when you need it most?

Photo: Expected drop in case of a 33% correction.

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It is true that investments at the lowest point of a bear market can yield the greatest returns when the market starts growing again. Many investors claim to be brave enough to buy stocks at the right time; only a few have the courage to actually follow through with the purchase. It is important to take the risk and invest when the market is at its lowest, as this is the key to the greatest benefits when the market recovers.

The S&P500 index has increased an average of 25% in the first three months of the last five bull markets. In addition, data collected over the last 20 years shows that more than one-third of the largest daily market increases occurred in the first two months of new bull markets, with half of these increases occurring during bear markets. As a result, it is more advantageous for investors not to try to determine the exact bottom of the stock market, but rather just invest when it seems like the right time.

S&P 500 did not end 2022 with positive returns. This would be a relatively unusual occurrence, as it is not usual for the S&P 500 to experience two consecutive years of negative returns. The last time this happened was between 2000 and 2002, following the Dotcom bubble burst.

Photo: Two consecutive years of negative returns for the SP500 index.

The FED’s decision to raise interest rates quickly, one of the fastest growths in decades, is reason to celebrate on stock markets. However, there is a concern that it may take some time for the effects of this tightening to be felt throughout the economy and for the impact on profits and shareholder value to be seen. Historically, bear markets have usually ended after the end of the economic tightening cycle. The full effects of tightening usually occur during a recession!

When will the bear market end?

A bear market usually ends when certain conditions are met, such as falling stock prices and increased pessimism among investors.

Currently, the conditions for a recession are not met; the NBER (National Bureau of Economic Research) has not declared a recession, the FED has not finished raising interest rates, unemployment has not significantly increased, the ISM Manufacturing index has only recently fallen to 49, and earnings estimates have only slightly decreased.

Photo: The Manufacturing Index has been a good indicator of recession in the past.

Let's look at how this has played out in practice in the last two economic crises.

In 2006-2009, the FED stopped raising interest rates just before the unemployment rate reached its lowest point. Then they began lowering interest rates, and after one year the unemployment rate had increased by two percent. The Purchasing Managers’ Index (ISM) reached its lowest point at the same time that the interest rate cuts ended.

In December 2008, the National Bureau of Economic Research (NBER) declared that a recession was underway and a few months later, in March 2009, the SP500 reached its bottom. In the chart below, we can see how these indicators appeared simultaneously and defined the bottom of the bear market.

Photo: Year 2006-2009; SP500 index, unemployment, interest rates, manufacturing index.

In 2000, the FED stopped raising interest rates just before the lowest unemployment rate was reached. Almost a year later, the Purchasing Managers’ Index (ISM) also reached its lowest point. After the interest rate cuts ended, unemployment increased slightly, by two percent. The National Bureau of Economic Research officially declared that a recession began in March 2001 and the S&P 500 index reached its bottom in October 2002.

Photo: Year 2000-2002; SP500 index, unemployment, interest rates, manufacturing index.

Today, the National Bureau of Economic Research has not officially declared a recession. The FED has not yet stopped its interest rate increases, although many believe that the 50 basis point increase in December was their last. Additionally, the FED raised its forecast for basic household spending at its last meeting, which means they are not satisfied with the current inflation rate. Furthermore, it seems that the Purchasing Managers’ Index has not yet reached its bottom, indicating that the economy’s strength will likely worsen. Unemployment, which was 3.5%, has likely stabilized at 3.7%, which is not a sign that the market will soon reach its bottom.

The S&P 500 index and employment are cyclically linked. In the last three recessions, the S&P 500 reached its peak when unemployment was at its lowest and reached its bottom as unemployment increased. This pattern is due to the stock market’s ability to predict the end of a recession before it happens.

Photo: A low value of the unemployment index is correlated with high growth in the SP500.

It is important to know that employment is generally an important indicator of recession, but it is a lagging indicator. Leading economic indicators, on the other hand, already suggest a recession.

For example, a drop in the ISM index is often preceded or coincides with a bottom in stock markets, as it is a leading economic indicator, while employment is a lagging economic indicator. This is demonstrated by the fact that in 2001 the index reached bottom twice within almost a 12-month span.

It appears that all participants in financial markets believe that markets will quickly turn around when the Federal Reserve changes direction and injects money into the system. While this is not impossible, it is unlikely. Last year, during the COVID-19 crisis, markets did not only respond to monetary easing, but also required fiscal stimulus to boost the economy and help stocks recover. Without both measures, the next recession is likely to unfold like past recessions.

We are at a major turning point, where bears will disappear and bulls will return to restore the market growth trend. This is similar to 1945, when the world emerged from World War II with high debt, negative real interest rates, fiscal decisions, and technological progress.