The average year has roughly 3 pullbacks of 5% or more and as you might have noticed, we just had our first. Each time it feels like the end of the world. There’s always a reason. Here are some since 2009.
The difference for most is that as your portfolios grew toward all-time highs to start the year, the raw dollar amounts on your weekly performance emails might have seemed higher than usual. But the percent changes in the stock market have thus far remained ordinary.
As for the reason why we have pulled back, you don’t have to look too hard. Turn on the news and you will see the primary culprits very quickly: acts of war in the Middle East and very stubborn inflation domestically.
While it’s hard to predict geopolitical events, this was supposed to the year that we saw numerous interest rate cuts from the Federal Reserve as inflation dipped back toward their target of 2%. Well, it’s been stuck in the mid-to-upper 3s. That’s not awful but it’s not enough progress to justify a rate cut according to Fed Chairman Jerome Powell.
To start the year, the options market was projecting 6-8 rate cuts in 2024. Now, the projection is 2 rate cuts with the first one occurring in September. To make matters more interesting, this aligns with the upcoming presidential election. Monetary policy is not supposed to be political. However, you better believe the White House will want the stock market high before people cast their ballots.
Bonds are another story. Longer duration rates have crept back up. It hasn’t been a bloodbath like the prior two years but they swiftly erased their year-to-date gains over the last few weeks. As we have discussed, longer duration bonds have a high interest paying cushion that compensates for some of this market value movement. Shorter duration like treasury bills are simply paying their 5%+ interest with no significant price change.
The most challenging aspect of this high inflation era is that stocks and bonds have kept a very high positive correlation — 0.69 out of 1.00 over the last 3 years to be exact. When stocks go up, bonds go up and all is well. When stocks go down, bonds go down and things feel really bad. Historically, this has not always been the case and it’s currently difficult to diversify unless you are using just treasury bills or ultra-short term bonds.
Right now, the stock market is oversold on most time frames while still remaining in a long-term uptrend as judged by the S&P 500 price above an upward sloping 200-day moving average. If you were a swing trader, you are getting ready to hit the buy button due to charts like these.
As you see, we haven’t been this oversold since October 2023 when stocks took off on a 5-6 month rally. No signal is perfect but this has been when the tide has turned in the past.
This post is an excerpt from a private client newsletter on 4/20/2024.