(Baird’s Investment Strategy Analyst, Ross Mayfield, CFA wrote the following piece in July 2022)
WHERE TO AFTER A HISTORICALLY BAD QUARTER?
It’s no big secret, but we just concluded one of the worst quarters for stocks and bonds since WWII. That’s the bad news. The better news is that it is in the rear-view mirror (good riddance). So, with a historically difficult run now behind us, what might lie ahead?
Let’s begin by looking at how the market reacted to past quarters like the one we just had. We closed down -16.4% in Q2, but we’ll use any double-digit drop since 1945. The good news is that when you see a quarter as bad as we just saw, it rarely repeats itself. And more often than not, returns look pretty good afterwards. As they say, “it’s hard to get worse than worst.” And in fact, if you look at quarters down 15%+, the average year-out return is even stronger.
The stock market is a forward-looking machine, the culmination of hundreds of thousands of investors looking out on the horizon, evaluating the economic landscape, and discounting their read on the future back to the present. So, when you have a quarter as bad as the one, we just did, it’s likely that a lot of future pain is already priced into the market. The good news about that is that once you get down 20% or more, you’re reflecting a lot of potential bad news, and thus the possibility for upside surprise is an easier bar to clear.
Now, that doesn’t mean we’ll be out of the bear market tomorrow. The average bear takes around a year from beginning to trough, and the positive returns shown in our table to the right aren’t often enough to recoup the entire downside of a bad quarter. Inflation is still hot, the Fed is still raising rates, geopolitical volatility is heightened, and more. There are still plenty of headwinds out there.
But the other unassailable truth about the stock market is “it’s gone up more than it’s gone down.” It’s the reason that the S&P 500 is up 366,000% over our timeframe DESPITE all of those nasty quarters listed. Still, in order to reap those rewards, persevering through troubling times is a necessity. We just lived through one, and as our Michael Antonelli notes, “There will be more recessions, selloffs, and bear markets. They will happen, it’s inevitable.” Luckily, your financial plan is built for this. So, stay focused, remember that a lot of bad news is already priced in, and perhaps take solace that bad quarters of the past have portended stronger returns to come.
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