Laura J. from Dubuque, IA asks: Hi Mitch, I’m just curious what happened to all the positive returns in the stock market over the summer. It felt like things were headed back in the right direction, only to collapse again. Hoping you could explain and share some thoughts on what to expect at the end of the year. Thank you.
Mitch’s Response:
Thanks for writing! Stocks staged a strong rally starting in mid-June that lasted until mid-August, a two-month period that gave many investors hope that the new bull market may have been underway. We now know, however, that in June and July investors grew far too confident that the interest rate cycle was nearing its peak, and the market was quickly pricing in some of this optimism. The case-in-point was that the fed-funds futures markets were projecting rates would top out at 3.44% in March of 2023, with rate cuts commencing in May of 2023.
But these forecasts were far too optimistic.
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Federal Reserve Chairman Jerome Powell reset expectations at an August 26 speech in Jackson Hole—making clear the Fed would accept higher unemployment and a potential recession in exchange for tamping down inflation. His comments sent stocks tumbling.
Another negative surprise came at the September 20-21 Federal Open Market Committee (FOMC) meeting, where the central bank projected the benchmark fed-funds rate would reach 4.4% by the end of the year. This forecast was of course higher than the market was expecting, and it also significantly raised the likelihood of a 75-basis point rate hike at the next meeting in November. Markets were again disappointed, and stocks continued selling off.
Looking back, the third quarter repeated a familiar pattern we’ve seen in 2022, where every time the markets have tried to price in a peak in the interest rate cycle, some combination of strong labor market data, stubbornly high inflation, and central bank policy has pulled it back. In other words, expectations for a pause or slowdown in rate hikes got too far out in front of the reality of Fed policy, which resulted in a bear market rally.
Investors should note though that bear market rallies are common and normal. Investors are constantly scouring new information to determine if longer-term growth forecasts are getting better, and the steady stream of economic data released every week will also shift expectations for when we may see a peak in inflation and thus a peak in the interest rate cycle. In the current environment, good news on inflation and bad news on the economy is likely to rally stocks, as both would signal to the Federal Reserve that monetary tightening is working.
Over the last 40+ years, there have been numerous bear market rallies that last an average of 44 days with positive returns usually around +10% to +15%, where cyclicals outperform. That pretty much fits the description of what we say in the summer of 2022, which I think just tells us the market is behaving normally given we’re nearly a year into a cyclical bear.
In a moment like this when it is easy to let headlines cause panic, looking back on how the markets historically reacted can bring investors insight and peace of mind. History has a way of calming our nerves especially as we face times of volatility. It can also help investors stay focused on the long term by shining a light on just how resilient the market can be.
To help you do just that, I recommend downloading our just-released guide, “Feeling Bearish? This is How Stocks Deal with Uncertainty.”2 This guide will show you how the market reacted to historical events. If you have $500,000 or more to invest, click on the link below to get your free copy today and learn more
Disclosure