This morning US investors were greeted to yet another unwelcome, though perhaps not unexpected, decline in the stock market. At the time of writing, the Dow Jones Industrial Average has slid over 300 points today, or over 1%, after recovering slightly from dropping over 500 points earlier this morning. The Nasdaq and S&P 500 have likewise dropped over 1% intraday. While these events are disappointing in themselves, they are part of a recent disturbing downtrend of significant proportions, including a brief dip into bear market territory and the worst performing first half for the S&P 500 in fifty years. Unfortunately, there only appear to be several possible paths forward, with none of them favorable to stock market bulls. Let’s explore what this means for traders and investors as we issue a warning: stock market looking bleak.
Path #1: Selloff by Further Rate Hikes
One likely possibility for the US economy is that the Federal Reserve continues implementing further rate hikes to curb hyperinflation. This seems quite plausible for three reasons: a) high inflation in the US has thus far persisted, with the most recent CPI data for May reflecting a 1% increase in inflation month-over-month, and an 8.6% increase year-over-year; b) historically, high inflation seems likely to continue, considering cooling the similarly overheated US economy forty years ago required double-digit target interest rates; c) Jerome Powell, Chair of the Federal Reserve, has already signaled that the Fed is willing to continue rate hikes as necessary, perhaps even resorting to more 75 basis point ones if needed.
If this comes to fruition, it would likely be bearish for the stock market since the Fed’s past several aggressive moves have ultimately prompted increased selling pressure for stocks. The Fed’s hawkishness particularly affects the stock market because its recent highs were due in large part to COVID-era dovish monetary policy, which shareholders ostensibly can’t rely on anymore.
Path #2: Selloff by Impending Recession
Another plausible possibility for the US economy is that it continues its descent into full-blown recession. Such features include recurring contractions in gross domestic product, higher unemployment rates, and lower consumer spending from the lack of work or decent income. This would likewise be a disaster for the stock market, since its performance is often interpreted as, and anticipated to be, a proxy for the health of the US economy. Low consumer spending equates to less money spent purchasing goods and services from businesses, as well as dwindling confidence and spare capital from potential buyers, sending share prices lower and forcing even more layoffs.
While a recession can theoretically cause low inflation via lower demand, and thus no more need for further interest rate hikes, the stock market would nonetheless be caught in the crossfire. While many economists anticipate recession being likely, if not imminent, even the Federal Reserve acknowledges the risks as they forecast higher unemployment and slower economic growth as unfortunate sacrifices for having stopped hyperinflation via contractionary monetary policy. The US stock market would thus be a central casualty if a recession is induced.
Path #3: Selloff by Stagflation
One particularly disturbing possibility for the US economy is the chance of stagflation, a nightmarish fusion of both recession and hyperinflation. This would entail most aspects of both paths 1 and 2 playing out simultaneously: economic activity would contract as consumers and businesses lose money in a vicious cycle, while prices remain unusually high, exacerbating the effects of recession. This unfortunately seems possible in the US because of how current global supply chain bottlenecks are contributing to inflation by restricting supply, causing the price of oil and other commodities to soar. Thus, there is a significant chance that this tragic phenomenon could occur, which would be doubly disastrous for the stock market.
The Bad News
Unfortunately, it is difficult to imagine a probable scenario in which the US stock market doesn’t plunge deeper into selling pressure. Continued bearishness over the next few years seems incredibly likely regardless of what exact problems deal these next few blows to the US economy. Thus, for any traders who are short-term stock market bulls, please know that the chances of a prolonged, near-future rally for equities seem slim. The US is no outlier, either; the global economy is currently afflicted with these same issues. We will have to weather this economic storm altogether.
Some Good News
However, for those who are long-term investors, any stock market selloffs can be understood as optimal buying opportunities. This is because the US economy, like other market or mixed economies, experiences business cycles: periods of expansion, followed by contraction, rinse and repeat. Due to the US’ abundance of natural resources, huge population, international influence, and more, the US economy is incredibly resilient and able to rebound from recession long-term.
This means that even if fundamentals don’t currently look good for the stock market, they are still promising through the decades, which net favors long-term shareholders and bulls. So long as investors stick to a thoroughly diversified portfolio, investing regularly in historically reliable funds such as index funds and other trustworthy ETFs, and abstain from premature selling due to worries and disappointment, bear markets present bargains for future wealth building.
The stock market is hovering near bear market territory, and the S&P 500 has experienced its worst performing half in fifty years.
If the Federal Reserve continues implementing large rate hikes to address hyperinflation, this will likely continue to be bearish for the stock market.
If the US experiences a recession, crippling the economy yet slowing inflation and eliminating desperate need for rate hikes, this will still be bearish for the stock market.
If the US experiences stagflation, a catastrophic fusion of both recession and persistent hyperinflation, this will be doubly bearish for the stock market.
The bad news: it is hard to imagine a bullish outcome for the stock market in the near future. If you are anticipating that this bearishness will end soon, don’t get your hopes up.
The good news: now is an excellent time to begin regularly investing in trustworthy funds, since stock selloffs present discounted buying opportunities for long-term investors.
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