Has the market correction ended?

After hitting a bear market low for equities in October 2022 (defined as a decline of at least 20% from peak value), U.S. markets were able to make up some lost ground in the subsequent six months. However, the stock market has recently seemed to be “on pause,” with prices varying within a small trading range.

According to Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management, investors “appear to be in a wait-and-see mode, looking for more clear indicators to give them confidence about the future direction of the market in one direction or the other.” There are numerous elements in play right now that could determine whether stocks will gain ground or start a sustained rally.

The stock market may be directly impacted by these factors, which also include steadily rising interest rates, persistently high inflation, and the risk of slower corporate earnings growth.

These and other elements will likely determine the stock market’s trajectory in 2023.

Recovering after a difficult year

Since both the stock and bond markets experienced reverses last year, it will be regarded as a challenging year for investors. The benchmark Standard & Poor’s 500 stock index fell by 25% from its peak in January of the previous year, reaching an index value of 3,583 in October 2022, when it reached its lowest point. Early in February 2023, at 4,179, the S&P 500 reached its peak on the recovery path. The index’s rising trend ceased, even though it had not yet recovered half of the losses it had sustained during the bear market of 2022. The S&P 500 index has fluctuated between 3,855 and 4,155 since then, which is still significantly below its peak in January 2022.

Periodically and for a variety of causes, the stock market will decline. Following a protracted bull market, adjustments may result from inflated market valuations. In other instances, they could be the result of outside influences that outweigh other basic elements that typically influence stock market performance.

According to Haworth, the growing amount of investor uncertainty will be the cause of the market’s decline in 2022. This unpredictability was mostly a result of three big occurrences:

  • Chronically high inflation
  • A substantial shift in the Federal Reserve’s monetary policy
  • The economic consequences of Russia’s invasion of Ukraine

Analyzing historical bear markets

The American stock market has seen four bear markets in the twenty-first century. As you can see, the most recent bear market cycle has not experienced a decrease as sharp as the prior three.

The price “bubble” in technology stocks, notably some early-stage dot-com companies, was blamed for the bear market from 2000 to 2002. A decline in housing prices significantly affected the 2007 to 2009 bear market. The COVID-19 pandemic shutdowns in February and March 2020 caused an economic contraction and a transient slowdown.

Haworth claims that “in 2022, we saw a massive change in sentiment.” The continuous nature of high inflation brought on investor angst. Demand for products and services outpaced supply, which led to higher inflation. The Federal Reserve (Fed) made policy changes to curb economic growth, yet rising inflation persisted, according to Haworth.

The volatility in the stock market is still present. However, outcomes have been erratic since the S&P 500 gained a lot of ground back in October and November 2022.

Major things to pay attention to

What elements might cause the current market “pause” to end and more definite, long-term movement in stock prices? Haworth keeps an eye on three crucial variables:

Continuous inflation. Supply chain bottlenecks and rising energy prices, two factors that contributed to the inflation spike in 2021 and 2022, have largely eased. But because of the surge in consumer demand, prices for “experiences,” including travel and entertainment, went up. The Consumer Price Index measured inflation, which peaked at 9.1% for the 12 months ending in June 2022 before falling to 5.0% for the 12-month period ending in March 2023. Haworth points out that the Fed’s main concern is how wage increases can impact inflation. There are signs that the rate of increase in average hourly earnings, which was strong in 2022, is decreasing. He points out that the unemployment rate is still historically low and that there are still a lot of job openings. The Fed might believe its inflation targets are within reach if that situation changes and the labor market weakens.

Interest rate policy of the Fed. One of the main causes of the stock market’s bear market turn was the Fed’s change in monetary policy for 2022. In a significant effort to curb inflation, the Fed raised the short-term federal funds rate from around 0% in early 2022 to roughly 5.00% by March 2023. The Fed’s rate increases raised yields across the board and raised the cost of borrowing money for borrowers. This is lowering demand in the desired way, which the Fed hopes will help contain inflation. Eric Freedman, chief investment officer at U.S. Bank Wealth Management, argues that if we examine the Fed’s definition of progress on inflation, they aim to bring it closer to their target of 2% annually. The question is how much longer inflation must remain stable before the Fed will once more alter its mind about raising interest rates.

Corporate profits. Early reports on first-quarter 2023 earnings (business profits) are higher than many anticipated, according to Haworth. Even yet, 2023 earnings projections are currently lower than they were in early 2022. Spending by both consumers and businesses determines earnings outcomes. Consumer spending on “experiences” is still strong, according to Haworth, “but spending on goods is slower.” Haworth also observes that firms are being careful with their spending. In addition, there has been a slowdown in consumer and commercial borrowing, probably as a result of increasing interest rates. Corporate bond issuances have decreased recently. Softer profitability may result as a result of this being the catalyst for slower economic growth. According to Haworth, the market may experience growth if investors’ faith in earnings increases. Investors may continue to be cautious about stocks in the foreseeable future as a result of the majority of firms’ regrettable reluctance to offer precise guidance on their profit projections.

Haworth predicts that the results of these three factors will have the greatest impact on how the stock market performs in 2023.

Potential market-impacting policy issues

Geopolitical events and policy considerations may not be deciding factors, but they may have an impact on investor mood in 2023. According to Haworth, markets may already represent the existing state of these problems, but any unexpected developments could have an impact on the capital markets, at least temporarily. Things to watch out for include:

Debate over the debt ceiling. The capacity of the American government to borrow money to cover ongoing costs is at risk. For the government to avert a debt default, Congress will need to approve further debt issuance, most likely before the end of this summer. The Democratic-led Senate, President Biden, and the Republican-led House are at odds over the specifics of a debt ceiling extension. This increases market uncertainty and may have effects on the capital market if the problem turns out to have a negative economic impact, as some forecast.

The conflict between Russia and Ukraine. Haworth points out that markets appeared to adapt to the stressors brought on by the war as the conflict now appears to be at a standstill more than a year after Russia invaded its neighbor. Haworth claims that the current economic situation is less difficult. We’ll be keeping an eye on whether grain harvests from Russia and Ukraine can pass easily via shipping lanes during the next months. We’ll also keep an eye on how well Western Europe can prepare for the coming winter by stockpiling energy supplies. Haworth asserts that any significant event changes the current course of the war of the market.

Escalating hostilities between the United States and China. The two biggest economies in the world had had a generally cooperative economic relationship until recent years when fresh tensions emerged. Although there are still many levels to the economic partnership, China’s priorities occasionally conflict with American interests. Market jitters could result from any significant issues (like China supporting Russia militarily in its conflict with Ukraine).

 Maintain a balanced perspective

It is common for the market to experience volatility and uncertain times. Remember that market ups and downs are likely to occur occasionally; over time, markets have proven to be able to rebound, advises Haworth. Given the variety of problems that add to the market’s near-term unpredictability, market volatility is likely to continue. Haworth argues that the market still faces numerous problems given the existing structural and policy underpinnings, even though a more favorable climate may eventually emerge.

According to Freedman, it’s crucial to keep the proper perspective on the markets. He advises investors to look at markets with a long-term outlook. It can be not easy to time the markets and try to be exact about when to enter and exit, according to Freedman. “Markets act exactly when you don’t expect them to,” the adage goes.

In these trying times, especially, Freedman emphasizes the importance of having a plan in place that guides your investment decisions. That is the basis of investing, he asserts.

Investors shouldn’t anticipate the sudden emergence of an “all-clear” sign indicating that market risks have diminished in 2023, according to Haworth, as the stock market will continue to experience volatility. “If you have money sitting on the sidelines, getting a better return on it should be your top priority.” Haworth points out that various fixed-income instruments, such as certificates of deposit and short-term U.S. Treasury securities, offer competitive returns. “As you consider accumulating long-term wealth, also take into account systematically investing a portion of your portfolio in the equity market, such as by dollar-cost averaging your available cash over a period of months,” Haworth advises investors with stock exposure to thinking about investing more in infrastructure and physical assets. These typically exhibit stronger protective traits under erratic economic conditions and also produce cash flow through aggressive dividend payouts.

Consult a wealth planning authority to confirm that your portfolio is set up in a way that is compatible with your long-term financial objectives and that you are comfortable with your present investments.