Stock Market Bottom Remains Elusive Despite Deepening Drop

US stocks are in the midst of their longest sell-off in decades.

Whether they are close to bottoming is anyone’s guess.

Market sell-offs have long stumped strategists trying to predict when they were close to being over. Some have ended with bursts of panic selling. Others, like the one that lasted from 1973 to 1974, came to an end after days of moderate trading volumes.

Many investors and analysts looking back at historic setbacks believe the current slide that has put the S&P 500 on the cusp of a bear market still has some way to go.

The index is down 19% from its January 3 high, flirting with the 20% drop that would end the bull market that began in March 2020. This year’s stock sell-off, now in its fifth month, has already it has lasted much longer than the typical pullback that occurs without a recession, according to Deutsche Bank.

However, the Federal Reserve is still in the early stages of its campaign to raise interest rates, which means that financial conditions will tighten further and put more pressure on stocks in the coming months. Many people are skeptical that the central bank can keep raising rates without pushing the economy into a recession, a period in which stocks have typically fallen about 30% since 1929, according to Dow Jones Market Data.

The data continues to suggest that this year’s sell-off, while painful, has yet to result in the kind of shifts in investment behavior seen in previous recessions.

Investors continue to hold a sizeable portion of their portfolios in the stock market. bank of america corp.

he said this month that his private clients have an average of 63% of their portfolios dedicated to equities, far more than after the 2008 financial crisis, when they had just 39% of their portfolios in equities.

A measure of expected market volatility has remained firmly below the levels it exceeded during previous sell-offs. The Cboe Volatility Index, or VIX, jumped well above 40 during the sell-offs of March 2020, November 2008 and August 2011. It has yet to close above that level this year.

Investors have not been quick to get out of some of the hardest-hit parts of the market. Exchange-traded fund ARK Innovation has netted inflows of $1.4 billion this year, despite being on track to deliver its worst returns in history, according to FactSet. Leveraged ETFs that offer investors a way to amplify bullish bets on the Nasdaq-100, as well as semiconductor stocks, have attracted billions of dollars in inflows this year.

“We still have to shake the foam off the markets,” said Cole Smead, president and portfolio manager of Smead Capital Management.

Like many other investors, Smead has been trying to identify companies with attractive valuations that he believes can withstand rising inflation and slowing growth. One company Smead has been eyeing is Starbucks Corp..

, whose shares were previously held by the company. But like just about everything else in the stock market, shares of the coffee chain have tumbled this year.

Shares of Starbucks fell 37%, on track for their worst year since 2008. The S&P 500 is down 18% for the year and posted its seventh straight weekly loss on Friday, its longest streak since 2001.

“Things will continue to get worse before they get better,” Smead said.

One reason many investors are cautious right now? Very high inflation. The Fed is raising interest rates to try to rein in inflation, which earlier this year rose at the fastest pace since the 1980s. Its goal is to achieve a “soft landing,” in other words, to slow the economy as far as it will go. enough to control inflation but avoid throwing the US into a recession.

Many investors fear that the central bank will not succeed due to past cycles of monetary policy tightening.

Going back to the 1980s, the US entered a recession four of the six times the Fed launched interest-rate-raising campaigns, according to research by the Federal Reserve Bank of St. Louis. This time around, the central bank has the added challenge of trying to rein in price increases, while Russia’s invasion of Ukraine and China’s zero covid policy add to supply chain disruptions and inflationary pressures across the board. the world.

“There is no chance that the Fed can squash inflation without significantly hurting domestic demand,” said David Rosenberg, president and chief economist at Rosenberg Research.

Rosenberg added that he thinks markets will have a hard time finding a definitive bottom before the Fed has finished tightening monetary policy, or has convinced investors that it is succeeding in reducing inflationary pressures without risking a recession.

Others point out that stock declines, while painful, have yet to reach the severity of previous bear markets.

Since 1929, the S&P 500 has declined an average of 36% during a bear market, according to data from Ned Davis Research.

The end of the sell-off will be “a great buying opportunity, but I don’t think that time is necessarily tomorrow,” Smead said.

Write to Akane Otani at akane.otani@wsj.com

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