But is it really different this time? Are the drivers of the recent market declines that different than the past?
I have been working in the investment industry long enough to say with some confidence that no, it is not different this time. The reasons for the decline are different, but there are some fairly consistent truths that run through all bear market declines.
Each time these types of declines occur, it’s tough to remember the past. The last prolonged bear market we experienced was triggered by the Financial Crisis. The S&P 500 Index peaked in October 2007, with precipitous declines over a period of about 1 ½ years before stabilizing in March 2009. The peak-to-trough loss of the S&P 500 Index was nearly -57%, and similar for the Nasdaq.
But, think about it. That was 13 years ago. For those retiring this year at age 65, a bear market of that magnitude had a very different feeling and impact on your psyche. At that time, you were 52 and still had many working years ahead of you. Fast forward 13 years and you are 65. The implications of market declines likely mean something very different.
But for us (older) portfolio managers, we have seen this all before – albeit triggered by different events. This time around, the Pandemic and access to easy money triggered inflation levels we haven’t experienced for over 40 years. The Financial Crisis was triggered by banks failing. The Dot.com bubble burst because of excessive company valuations and the attack on September 11.
But there are themes that repeat. Below are what we consider three market “truths.”
- Market cycles have persisted throughout history. While it may not feel like it, we are in a standard market cycle. A market cycle refers to stock market trends or patterns that emerge during different phases of business environments. There are four stages of a market cycle including the bottoming out phase, accumulation with prices increasing, flat with indecision about market direction, and downtrend/prices declining. This cycle repeats itself over and over again, with certain sectors performing better (or worse) during these phases.
- We believe we are currently between phases 3 – 4 and expect that interest rates will likely peak in 2023. Note: The stock market is “forward-looking” so the stock market will start to bottom and start to recover before this shows up in the economy.
2) Active and passive management are both valid investment approaches. Active investment management means that the investment manager will apply investment analysis, research, and quantitative tools regarding which assets to buy and sell. By contrast, passive management follows simple rules that aim to track an index or other benchmark by replicating it (i.e., an S&P 500 Index fund.)
Invariably when the market is moving up, everyone expounds on the benefits of passive management. Then during periods of steep market declines – like we are experiencing today – active management becomes “all the rage.”
We are steadfast believers of – and we apply – both approaches. We are risk managers at heart, so will sell equity positions when markets are in a steep decline. Active management doesn’t preclude clients from experiencing losses – but if declines become even more pronounced, the cash from the sales provides a bit of a “seat belt” on their accounts. This approach also provides some “dry powder,” with the goal of buying equities when they are “on sale.”
3) Interest rate policy has a direct impact on the economy and the markets. The Federal Reserve uses interest rates to stimulate or slow the economy. In most instances, the stock market responds negatively to an increase in interest rates and positively when rates are going down (see table above.) This has been proved over the years:
- The highest fed funds rate was 20% in 1980 in response to double-digit inflation. Paul Volcker’s rate hikes during this period sent the US economy into the worst recession since the Great Depression. But his aggressive moves quelled inflation and the economy eventually recovered and enjoyed more than a two decades stretch of economic growth, with the stock market rallying strongly during this period.
- The lowest fed funds rate was zero in 2008 during the Financial Crisis and again in March 2020 in response to the coronavirus pandemic. In both instances, the Federal Reserve lowered interest rates to bolster a failing economy. As interest rates were cut, the stock market rallied.
- The Federal Reserve started aggressively raising interest rates earlier this year in an effort to “cool off the economy” and reduce inflation. This has resulted in the recent stock market declines.
Managing money is extremely challenging. We are consistently humbled by the market and market dynamics. However, we have worked in the industry for a long time and strive to leverage these truths, understanding that there are no guarantees.
Reach out if you would like to discuss any of these concepts, or have us do a complimentary review of your investments.