Hello, friend!
A rough week in stocks culminated with its worst day on Friday, with the S&P 500 dropping by -3.37%. This marks two consecutive negative weeks for the most widely accepted barometer of the US stock market.
Week of August 15 – 19: drop of -1.19%
Week of August 22 – 26: drop of -4.04%
This brings the total decline over the past two weeks to -5.18%, as the S&P has fallen from a closing price of 4,279 on Friday the 12th to a closing price of 4,057 yesterday. Let’s try and make sense of this.
Normal Market Volatility
The stock market doesn’t go up in a straight line. If you’ve seen a long-term chart, you know the market moves in a very choppy fashion.
And we just got done with an incredible 2-months. We saw a staggering gain of around +17.5% from mid-June to mid-August (S&P 3,666 closing price on 6/16/22 versus 4,305 closing price on 8/16/22). If we annualize this, including compounding returns, the total gain would be around +163%.
Considering the best 12-month return in the history of the S&P 500 was +61% (in the 12 months ending June 1983), a gain of +163% is a wee bit of a stretch. So it is totally normal and expected to see a bit of a pullback after the recent rally.
Of course, it’s possible that the mid-June through mid-August run was just a “bear market rally.” Meaning it was just a temporary relief for a bear market that began in January, and we are headed for new lows.
But…
Economic Prospects
As I highlighted last month, despite having two consecutive quarters of GDP contraction (the technical definition of a recession), it is often the direction that matters more to stocks. In Q1 GDP contracted by -1.9% and in Q2 it contracted by -0.9%. It was trending in the right direction.
Well, this week, we saw a slew of economic data come in slightly better than expected (typical for recoveries). And this included an upward revision on that Q2 GDP number, which now sits at -0.6%. Making that directional aspect look even better.
The Fed
If you listened to the media on Friday, the big stock market decline was because of comments by Fed Chair, Jerome Powell. He indicated that the Fed would “use its tools forcefully” to fight inflation, which is still running a bit hot. He also indicated that this could cause some pain ahead for the economy.
To me, this means he does not see a weakening economy to be much of a problem. The primary Fed tool for fighting inflation is raising interest rates, which is often viewed as a detriment to the economy. Because it can slow the rate of lending, which is a big driver of economic growth. If a weakening economy was a big concern, would he have used such strong languaging?
It seems to me like this announcement could have simply served as an excuse for a normal pullback, rather than a legitimate reason for further downside.
Remember, things don’t have to be good for stocks to go up. They just have to be “less bad” than expected. It still feels to me like an environment full of fear and negative expectations. Which means the bar is pretty low for continued improvement.
* percentages are estimates, based on data pulled from Yahoo Finance