Wall Street is having one of its worst starts to a year in decades, but investors hoping for immediate respite are likely to be disappointed
History is not on their side.
The only surprise about the S&P 500′s slide of around 6% in the first three weeks of 2022 is the timing. Research shows that in years when the index records its shallowest corrections, drawdowns the following year are always deeper and returns are always lower, sometimes negative.
The start to 2022 is following exactly that pattern, even though there are 11 months left for the market to recover and end higher as is usually the case, including years following small corrections.
Last year, the S&P 500′s biggest correction was 5.2% in the month through Oct. 4, which would put it among the 10 shallowest pullbacks since 1950. These 10 declines span a range of 2.5-5.8%.
According to Truist Advisory Services, the average of these drawdowns is 4% and the average index total returns in those calendar years is 29%, almost exactly the same as 2021.
What happens the following year is instructive. The average of the largest drawdown is 13%, with declines ranging from 6% to 27%, and total returns average just 7%. That would be lower than the consensus 2022 earnings growth forecast of 8.6%.
Ryan Detrick, chief market strategist at LPL Financial, notes the average index price gain in the year following these shallow corrections is just 4.3%.
In the first three weeks of January, the S&P 500 has fallen 6.5%, already a larger reversal than last year’s biggest.
“Even though this feels really bad, it is actually somewhat normal,” said Truist’s co-chief investment officer Keith Lerner.
Wall Street is buckling under the weight of a dramatic upward shift in U.S. interest rate expectations, with inflation at a 40-year high of 7% and Fed officials sending strong signals that they are ready to act aggressively.
Lerner is not losing confidence in a rebound just yet. He notes that the S&P 500 rises 85% of the time when the economy is growing, and with U.S. GDP expected to expand by 4% or more this year, the risk of recession is low.
But the warning signs are flashing.
Volatility is rising, the intraday swings in the S&P 500 are getting wider, and the market is crumbling regardless of whether bond yields rise or fall.
These drags are weighing twice as heavily on the tech sector, and the Nasdaq is down 10.5%. Thursday marked the first time in over 20 years that the Nasdaq was up more than 1% intraday and finished down more than 1% on back-to-back days, according Bespoke Investment Group.
These conditions are likely to persist as long as fear and uncertainty surrounding U.S. monetary tightening persists. While money markets are fully discounting four 25 basis-point rate hikes this year starting in March - and starting to look at a fifth - institutional investors are nowhere near that.
Bank of America canvassed 329 participants, who collectively oversee $1.1 trillion, for its January Global Fund Manager Survey. Less than 20% of those surveyed predict four hikes this year. More of those surveyed expected just two increases than those who saw four.
James Bianco, president of Bianco Research LLC, says this shows that the equity market adjustment is not over yet.
“The institutional investment community still doesn’t think inflation is a problem. That’s a problem for Wall Street,” he said, adding that some rarely seen market moves this week lend weight to that view.
The S&P 500 was up as much as 1.53% on Thursday, only to close 1.1% in the red. There have only been five days since mid-2009 that the index has been up more than 1.5% intraday and then finished down more than 1%. Two of them were in March 2020 during the initial COVID-fueled collapse.
Of course, the S&P 500 ended that year up 16%, but it was far from a smooth ride. This year promises to be bumpy too.
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