Will Stocks Fall Further?

On June 13, 2022, the S&P closed more than 20 percent below its most recent high, officially meeting the criteria for a bear market. The news didn’t come as a surprise. Most investors and market experts had suspected a bear market was in the works for some time.

Though the index has come up slightly since mid-June, no one is prepared to discount the possibility that further declines could be on the way. What caused the drop in stock prices? And will stocks fall further? What factors contributed to year-to-date losses, and do those factors still have the power to deliver additional pain?

What Is Causing The Bear Market?

Many investors and market experts rely on hard data to make trading decisions, and they are more comfortable when market conditions can be quantified. That preference prompted S&P Global to assign a threshold at which the S&P 500 is “officially” in bear market territory. Specifically, a bear market is considered official when there is a 20 percent drop from the most recent market high.

However, there is nothing special about the 20 percent mark – S&P Global could have chosen 18 percent or 25 percent as the threshold. A bear market is more about general sentiment and whether investors pursue high-risk/high-potential assets or focus on safer options.

The factors that play into investor sentiment include any or all of the key economic indicators. These include:

  • Real Gross Domestic Product (GDP)

  • Nonfarm Payrolls

  • Unemployment Rate

  • Consumer Price Index (CPI)

  • Producer Price Index (PPI)

  • Consumer Confidence Index

  • Consumer Sentiment Index

  • Retail Sales

  • Durable Goods Orders

  • Federal Reserve Interest Rate Announcements and other actions

A combination of these measures offers a clear picture of where the economy has been, where it is now, and where it is going near-term. When investors see signs of economic trouble ahead, they move to safer assets. That causes stock prices to drop, creating a bear market.

The market crash of 2020 was unusual because there was no lead-up. COVID-19 caused an abrupt economic shutdown, which temporarily alarmed investors. Efforts to prevent economic disruption were successful, and the market recovered in short order. The “official” bear market only lasted a little over a month.

Why Is Inflation So High In 2022?

The current bear market is likely to stretch quite a bit longer because there is a perfect storm of negative economic indicators. The most influential include rising inflation and interest rate increases.

The Russian invasion of Ukraine had an instant effect on oil prices, which means higher fuel costs. That makes it less affordable to heat homes and businesses, and it causes fuel prices to go up.

In addition to making it more costly for consumers to get where they need to go, higher fuel prices contribute to inflation. Ships, planes, and trucks transport goods to store shelves and consumers’ homes. When it is more expensive to bring products in, the extra expense is passed along to shoppers, leading to inflation.

As of June 30th, inflation was up to 9.1 percent – a figure that hasn’t been seen in more than 40 years. The Fed increased interest rates several times this year to bring inflation under control, but so far, those increases haven’t had the desired effect. What they have done is spook investors, directly contributing to the drop in stock prices.

Will The Stock Market Continue To Fall?

The Efficient Market Hypothesis (EMH) is a theory that the stock market reflects all available information. In other words, it says that every stock is priced correctly and fairly at any given moment. While plenty of exceptions illustrate that the theory isn’t infallible regarding specific stocks, it is generally accurate in terms of the market as a whole.

The S&P 500’s year-to-date losses reflect all available information from the key economic indicators, including a nearly two percent drop in GDP for the first quarter of 2022.

Right now, economists estimate another reduction for the second quarter, though the final calculation is not yet available. Though technically, no hard-and-fast rule says two consecutive quarters of GDP decline equal recession, most investors consider two straight quarters a bad sign for the market’s immediate future.

Those concerns, along with the possibility of continued inflation, increasing oil prices, rising unemployment, and other signals of economic turmoil, are factored into the market already. For the most part, the market discounts stocks between 6 and 12 months out. However, if newly released key economic indicators signal economic contraction, stocks will fall further.

How Long Will Inflation Stay High?

At the moment, inflation is the most significant economic concern in political circles, and there is a lot of focus on predicting when inflation will come down. That single factor, once controlled, may be enough to send the economy and the market back up.

A few areas are seeing price relief – or at least a pause in climbing costs for consumers. Examples include big-ticket tech and electronics such as smartphones and televisions. Many travel-related services have also hit a price plateau, including hospitality and airfare.

A very limited selection of food products is beginning to see price declines, including pork and beef. That’s helpful, but it isn’t nearly enough to push inflation down. Housing costs alone are enough to keep inflation at its current rate, and new vehicle prices won’t return to more reasonable levels until computer chip production catches up with demand.

That suggests inflation will remain around nine percent for the rest of 2022 and perhaps well into 2023. In response, the Fed is likely to continue increasing interest rates, and every time that happens, stocks may fall further.

Is Now A Good Time To Invest In The Stock Market?

There is good news for investors who have watched their portfolios lose value, and there is great news for those who haven’t lost money yet. Historically, the stock market has always recovered its losses and has always gone on to achieve new highs.

For those already facing losses, the best strategy is to be patient. Losses aren’t realized until stocks are sold. Assuming the stocks in question have the hallmarks of financial strength and future growth, patience will probably pay off long-term.

For those who haven’t invested yet, now is the time to buy stock at discounted prices. Some of the most dependable companies in the S&P 500 are trading far below their recent peaks, so those who buy now can enjoy enhanced returns when the market recovers.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.