Same Same….but Different?
That’s a saying I learned while backpacking in Thailand years ago. Pretty much sums up the market today. We’ve all certainly experienced bull markets – we’ve been in one for over ten years. Bear markets are a bit more rare. We experienced a brief one in 2020 but the market finished that year up almost 20% wiping out the losses. The worst one we’ve seen in recent history is the bear market of 2007-2009 which lasted 1.3 yrs. and sent markets tumbling a gut-wrenching 51%. But the year ended up over 25% and 2010 brought a nice return of 15%.
With the declines since the beginning of the year, everyone is wondering what’s happening on Wall Street??
Google searches have been focused on the state of the market (and the economy) with most popular searches featuring the following popular queries: “Is the market crashing?” And “why is the market crashing?”
The Dow Jones Industrial Average (DJIA down -3.97% YTD) just posted its worst weekly loss since October 2020 and the S&P 500 Index (SPX down -8.48% YTD) and the Nasdaq Composite (QQQ down -11.60% YTD) logged their worst weekly percentage drops since March 20, 2020, according to Dow Jones Market Data.
What is a market crash?
There is no precise definition for a “crash”, but it is usually described in terms of time, suddenness, and/or by severity.
Some investment analysts characterize a crash as a decline in an asset of at least 50%, which could happen swiftly or over a year, but acknowledged that the term is sometimes used too loosely to describe “run-of-the-mill” downturns.
Experts, given their many years of experience in bull and bear markets, say declines of 0%-5% are called “noise”, but the closer we get to 5% the louder the noise. A 5%-10% decline qualifies as a pullback, a drop of at least 10% is a correction and a fall of 20% or greater is a bear market.
The overall equity market’s current slump doesn’t meet the crash definition, but stocks are in a fragile state. It’s not crashing but it is very weak.
What’s happening?
Equity benchmarks are being substantially recalibrated from lofty heights as the economy heads into a new monetary-policy regime in the battle against the pandemic and surging inflation. On top of that, doubts about parts of the economy, and events outside of the country, such as China-US relations, the Russia-Ukraine conflict and Middle East unrest are also contributing to a bearish, or pessimistic tone, for investors.
Those events have markets in or near a correction or possibly headed for a bear market, which are terms that are used with more precision when talking about market declines.
The recent drop in stocks, of course, is nothing new but it is unsettling for new investors and even some veterans.
The Nasdaq Composite entered correction territory last Wednesday, ringing up a fall of at least 10% from its recent Nov. 19 peak, which meets the commonly used Wall Street definition for a correction. The Nasdaq last entered correction on March 8, 2021. On Friday, the Nasdaq Composite stood over 14% below its November peak and was inching toward a so-called bear market, usually described by market technicians as a decline of at least 20% from a recent peak.
Meanwhile, the blue-chip Dow industrials stood 6.89% beneath its Jan. 4 all-time high, or 3.11% away from a correction, as of Friday’s close; while the S&P 500 was down 8.31% from its Jan. 3 record, putting it a mere 1.69% from entering a correction.
Worth noting also, the small-capitalization Russell 2000 index (RUT down -1.86% YTD) was 18.6% from its recent peak, putting it 1.4% from a bear market. As we have seen, the more aggressive asset classes – small and mid-cap stocks, tend to fall harder when markets decline.
Underneath the shift in bullish sentiment is a three-pronged approach by the Federal Reserve toward tighter monetary policy:
1. Tapering market-supportive asset purchases, with an eye toward likely concluding those purchases by March.
2. Raising benchmark interest rates, which currently stand at a range between 0% and 0.25%, at least three times this year, based on market-based projections.
3. Shrinking its nearly $9 trillion balance sheet, which has grown considerably as the central bank sought to serve as a backstop for markets during a swoon in March 2020 caused by the pandemic rocking the economy.
Taken together, the central bank’s tactics to combat high inflation – CPI clocked in at 7% for December -would remove hundreds of billions of dollars of liquidity from markets that have been awash in funds from the Fed and fiscal stimulus from the government during the coronavirus crisis.
Uncertainty about economic growth this year and the prospect of higher interest rates are compelling investors to reprice technology and high growth stocks, whose valuations are especially tied to the present value of their cash flows.
Excessive Fed liquidity had the effect of inflating many asset classes, including meme stocks, unprofitable tech stocks, and cryptocurrency.
The rise in yields for the 10-year Treasury note, which has climbed more than 20 basis points in 2022, marking the biggest advance at the start of a new year since 2009, is a symptom of the expectation of liquidity being removed.
The rate-setting Federal Open Market Committee is likely to spend its Jan. 25-26 meeting laying the groundwork for a further shift in policy, which the market is now attempting to price into valuations.
For those invested in cryptocurrency….ouch!
Cryptocurrency volatility can be partly attributed to an “immature market”. Anything from a celebrity tweet to new federal regulation can send prices spiraling. If Elon Musk puts hashtag Bitcoin in his Twitter bio, it can send Bitcoin up 10%.
This unpredictability is part of the reason why we warn against investing a large amount of your portfolio into a risky asset like crypto. We recommend our clients keep their crypto holdings to less than 5% of their overall portfolio.
For new investors, day-to-day swings can seem frightening. But if you’ve invested with a buy-and-hold strategy, dips are nothing to panic about. A simple solution? Don’t look at your investment daily.
Bitcoin, Ethereum, and the broader cryptocurrencies have been facing waves of selling, with the world’s most-traded digital currency, Bitcoin, down another 8% amid a selloff that has seen the digital token shed about a 25% of its value in January alone.
Bitcoin fell to $33,070, its lowest level since July 24, marking a 25% plunge since Jan. 3. From its Nov. 8 peak of $67,553.95, the cryptocurrency is now down more than 51%. The broader cryptocurrency market itself has seen around $1.7 trillion wiped off its value over the last 74 days.
Ethereum, the second-largest cryptocurrency, slid more than 12% to $2,205, its lowest since July 28. The native token of Ethereum’s blockchain has lost 38% this month. Other prominent coins like Solana’s SOL, Cardano’s ADA, and Polkadot’s DOT were down anywhere between 12% and 15% as of 1/17/2022.
Declines across the cryptocurrency market have seen a rocky start to the year as investors reassess where the U.S. and global economy is going and what the Federal Reserve and other central banks are going to do to tamp down strong growth and accelerating inflation.
The reason: bitcoin and other cryptocurrencies have become more entwined with the traditional stock market, with bitcoin alone near its highest correlation with the stock market since September 2020. That means when the stock market goes down, which it most definitely has since the kickoff of 2022, so does bitcoin.
Those who continue to believe in bitcoin’s short-term valuation levels also continue to believe in its long-term viability as an asset that can act like a commodity. The argument for bitcoin’s value is similar to that of gold: there’s only so much of it out there to be mined, and the more people want it, the higher its worth becomes.
Bitcoin specifically is limited to a quantity of 21 million; with the final coins projected to be mined by 2140. On the flip side, bitcoin and other digital-asset bears argue that it is impossible to put a real-time value on something that doesn’t physically exist.
At the same time, bitcoin’s wide adoption as store of value and as a hedge against other types of investment volatility mean it is now acting a lot more like the stock market — except without the diversity.
How often do markets crash?
Investors ought to be forgiven for thinking that markets only go up. The stock market has been amazingly resilient, especially during the pandemic. Once we have a couple of years of positive market returns, the negative returns tend to fall into the background, forgotten.
We have to take into account that markets tend to do a lot of digesting after a year when returns have been 20% or greater. The S&P 500 registered a 26.89% gain in 2021, 18.40% in 2020 and 31.49% in 2019!
But the market is doing what it does. A bull market takes the escalator up, but bear markets take the elevator down, and as a result people get very scared when the market declines.
It is important to know that markets can swing back in a hurry after downturns. It can take the S&P 500 on average 135 days to get to a correction from peak to trough and only 116 days on average to get back to break-even based on data going back to World War II.
This downturn may also be exacerbated by seasonal factors. Markets tend to do poorly in the second year of a president’s tenure. It’s called ‘the sophomore slump’.
There have been 20 other occasions when the S&P 500 index posted a calendar year gain of 20% or more and then experienced a decline of at least 5% in the subsequent year. When a large decline occurs after a big gain in the previous year, it has historically happened in the first half of the new year. On the 12 historical occasions, this has occurred, the market has gotten back to break even 100% of the time.
Some experts say that given the S&P 500’s drop of over 8% YTD, the probability of a 10%-14% drop from here is about 30%, while there is a one-out-of-five chance of a total drop of 30% or more from current levels.
Still, declines of 5% or more are a frequent occurrence on Wall Street. On the other hand, there is a similar probability that the current decline eventually turns into something twice as large. And a similar probability the current decline instead is over.
Confusing, right?!
Well then…What should investors do?
The best strategy during downturns is to DO NOTHING. But it all depends on your risk tolerance and your time horizon. Doing nothing is usually the best strategy.
Pullbacks can be opportunities for great deals. Investors often forget the classic ‘sell high, buy low’. Many stocks and investments are ‘on sale’ right now and offer great opportunities to get in at lower prices than we have seen in 3+ years. Contrarians find value investing when others are fleeing.
That can be a very profitable strategy if you have the risk tolerance to buy and perhaps see the market continue to decline. Other investors look for places to ‘hide’. Some areas that may do better in market downturns are defensive sectors, such as consumer staples, utilities and energy, which often carry healthy dividends, and higher-yielding investments like preferred stock can be a good option for investors looking to hedge in the face of possibly more volatility.
A small bright spot is the Fed raising rates this year which means those abysmal returns we’ve had in cash and CDs over the last few years will finally start to turn around. On the flip side, that also means that we should see those 2% mortgage rates disappear and HELOC rates to increase.
It is best not to do anything rash. But some investors have more reason to be concerned than others, depending on their age and investment profile. For older investors in retirement, this can be an anxiety, panic-inducing time. For anyone under 50 (who is not retired) with a 10+ year time horizon, the answer is pretty clear – stay put and ride it out.
Ultimately, investors need to be cautious and smart about how they think about the market, even in the face of so-called crashes.