It's not surprising with all the news to find we are experiencing major market corrections after three years of unprecedented growth between 2019 through 2021. Our expectations were elevated to unreal expectations that burst at the beginning of January 2022. The twin dragons of inflation and the Fed stepping in to raise interest rates combined with further supply chain concerns over China locking down its ports and the Russians invading Ukraine is too much for the market to continue climbing “the market wall of worry”.
Therefore, it’s only realistic to expect real gross domestic product growth to decline and to recognize that the risk of this correction could slide into a recession if the Federal Reserve raises interest rates too sharply. It is a tight rope that former Fed Chairman Greenspan successfully navigated the market into a soft landing in 1995. Fed Chairman Powell is tested with the same objective: to slow inflation and this overheated market, yet not stall the economy. Currently the economic underpinnings appear sustainable as measured by wage gains, job creations, and high job demand for workers.
Next let’s touch on current issues affecting this bear market:
- Money supply: It’s availability or lack thereof, given interest rate increases and the Fed releasing bonds in the open market. That is the Federal Reserve’s obvious power to reduce the overall level of demand by raising rates and reducing the loaded 9 trillion balance sheet. Resulting in home mortgages becoming less affordable calling the housing boom to sellers. Coupled with higher consumer borrowing cost affecting the individual’s consumer activity.
- High inflation: Government policy and programs instituted to bring us out of the Great Depression of the 30s were mimicked at the beginning of this century when Fed Chairman Ben Bernanke and Secretary of the Treasury Henry Paulson requested billions from Congress to deal with the “Great Recession” and again in 2022 Congress infused over $1 trillion to keep the economy from closing due to the pandemic; this infusion of government spending resulted in more dollars chasing fewer goods.
- Rapid growth: The most recent Federal Reserve “page book survey” of economic conditions illustrates moderate expansion despite hiring an employee retention challenges. Consumer spending remains firm in the pandemic although the supply of goods – supply chain – blockages and tight labor markets pose significant challenges in meeting the demand.
- Interest rates: The Federal Open Market Committee (FOMC) has raised interest rates on federal funds by 0.5% in June and is expected to raise it again in July at its next meeting in an attempt to cool down inflation while not stalling the economy.
- Stock price valuations: Stock prices are based on expected earnings – so as earnings fluctuate, so does stock prices. Companies are starting to report expected lower earnings going forward suggesting lower stock prices.
In conclusion, expect more market volatility. Consider continuing a dollar cost averaging approach for investing in this volatile market as we were buying at discount prices. We do not suggest a "knee jerk" reaction in moving to cash solely based on current market activity. Corrections, measured by a 20% decline in the market, or recessions measured by a 30 to 35% decline include their followed by surges in the market. And this market may take 6 to 9 months to correct itself as historically it has.