When are stocks falling?

There was nowhere to hide in stocks in the second quarter, with the S&P 500 down about 16%. More than half of this decline occurred in June alone. No S&P 500 sector was higher for the quarter. Dividend strategies were the relative winners of the quarter. Beyond equities, bonds fell during the quarter, but less than equities.

Year-to-date, the S&P 500 is about 20% lower, with only the energy sector up for the year. Interestingly, regulatory filing shows Berkshire Hathway continuing to buy Occidental Petroleum stock
(OXY) and now owns more than 16% of the company. A previous article explained why Warren Buffett’s Berkshire Hathaway
could add to its stake in Occidental Petroleum. Dividend strategies have been the best performers so far this year. Somewhat surprisingly, small businesses have slightly outperformed since the start of the year. The epicenter of the losses is in growth stocks which were the first to fall and helped usher in the bear market.

Many experts have noted that this is the worst start for the S&P 500 since 1970. While this year turns out to be similar to 1970, the upside is that the S&P 500 rallied strongly in the second half and the index ended a bit. better than even for the calendar year. Most years with intra-annual declines of this magnitude end in the red for the calendar year, but there are also many instances of sharp reversals into the green. While it’s silly to predict which one we’ll experience in 2022, it’s worth remembering not to be too pessimistic about the market outlook despite the awful start to the year.

The deterioration in the outlook for the US economy over the next twelve months is an important cause of the gloom weighing on stock market sentiment. The odds increase that the economy could slide into a recession within the next twelve to eighteen months. However, waiting for the economy to bottom out has always been a mistake. Stocks have typically been 28% above their lows as the economy bottomed. In eleven of the last twelve recessions, the S&P 500 bottomed before the end of the recession. The only outlier was the 2001 recession, associated with the bursting of the tech bubble.

Stocks typically bottomed about six months before the economy hit, but bottomed for up to ten months before the economic decline ended. During the 2001 recession, stocks hit a nine-month low after the economy recovered.

Buying stocks after a 20% decline generally resulted in better returns over subsequent one- and three-year periods. There’s no guarantee stocks will recover quickly, but the median bear market lasts about a year. While the stock market bottom is impossible to predict, using improving economic activity as a signal has been a recipe for underperformance.

Investors should always focus on an asset allocation that provides the financial means to persist despite volatility and economic downturn. In addition to holding safe and liquid assets to cover living expenses in the event of economic and market turbulence, this downturn should be a long-term buying opportunity for those able to increase their equity positions. Within stocks, investors should focus on companies that can survive a likely recession and prosper once the storm has passed. Given the threat of inflation, the company’s power to pass on price increases without collapsing demand for its products is critical.

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