What Happened in the Stock Market This Year?
Andy Pratt, CFA, CAIA
What is Happening in the Stock Market?
It is fair to ask what is happening in the stock market as we are checking a number of the negative stock market news check boxes this year.
- Russia’s invasion in Ukraine is the definition of geopolitical risk.
- The restrictions resulting from China’s zero-COVID policy are further disrupting manufacturing and supply chains.
- Domestically, inflation is running as hot as it’s been since the 1980’s, which is pushing the Fed to raise interest rates to reinit in.
You can’t point to just one reason explaining the market pullback, but rather it’s some combination of a lot of different things.
Rotation from Growth to Value Stocks
One point that is less talked about but perhaps most important is the rotation from Growth to Value underlying the sell off. As we’ve previously shared, Growth valuations relative to Value had stretched well beyond historic norms. Their decline is largely fundamentally based and justified. The rest of the market is caught in the downdraft but, fortunately, excessive valuations are being resolved, so conditions exist for the market to stabilize. Once that occurs prospects ahead are solid.
It was easy to chase shiny objects the past few years as so called “innovative” investments soared, but one of the main lessons learned from this episode is the importance in staying disciplined. The tech-heavy Nasdaq is down 28% this year. Bitcoin is down 37%. The ARKK Innovation ETF, the fund that gained fame during 2020 for its astronomical performance investing in low profitability, expensive companies with a good story, is down 60%. A cryptocurrency associated with a “stablecoin” was nearly a total loss. Meanwhile, the boring segment of the market is fairing relatively better. Large Value stocks are down just 8%, not even in correction territory.
An Optimistic Outlook on Market Futures
While news headlines like to highlight the negative to get clicks, there are reasons to be optimistic moving forward. This type of market volatility is not an unusual occurrence in the stock market. The price you pay for the long-term excess returns available by investing in stocks is market volatility such as this. What we are experiencing right now is entirely normal. While it is natural to focus on the short-term, stocks have been a great deal over the past three years. Even with the pullback, the S&P 500 has grown 13% annualized, better than the long-term average. Investors should be very happy with the growth of their portfolios.
From a macro standpoint, the key thing propping up outlandish valuations in the Growth segment of the market was near zero interest rates. With interest rates much higher now, the math discounting the future stream of earnings of these companies can no longer support the sky-high valuations. Regression to the mean was inevitable in this space and, again, disciplined investors were rewarded by remaining diversified. Some people are concerned about a looming recession, but recessions are typically the result of overcapacity in the economy. The issue right now is under-capacity as manufacturers can’t keep up with demand. Results at the company level are strong and that bodes well for investments moving forward.
How to Take Control in Volatile Markets
It is best to take control in volatile markets and if you are itching to take action, we will leave you with a couple of things you can do to take advantage of the current market.
- Use this opportunity to harvest losses in your taxable investments. Rebalancing during times of market distress can increase after-tax returns. Many people only think about tax-loss harvesting near the end of the year, but it should be a year-round game. Just be sure to stay fully invested and understand the wash sale rule.
- Invest any extra cash you have on the sideline. We don’t recommend keeping a large cash balance, but if you have cash on the sidelines, use this as a sign to put it to work. If you are uncomfortable putting a big chunk of cash into the market right now, dollar cost average in over the coming weeks and months to spread out the timing risk. You don’t have to be perfect picking the bottom if you have a long-term focus.
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