Dear Readers,
Since the start of the year, we have been taken on a roller coaster ride by the market, especially the NASDAQ. S&P500 has corrected 9.2% and NASDAQ 14.7% (correction territory). The stock market has never been down this much 16 trading days into a year. Both indices fell below its 200 days moving average for the first time since the Covid crisis in March 2020. That’s the most on record at this juncture, according to Bloomberg data that goes back over nine decades, though drawdowns have been faster in prior years before quick rebounds, most notably in 2009.
The market is reacting to the recent FOMC meeting which indicated that the FED is looking at raising rates at a faster speed than anticipated to combat the alleviated inflation numbers. Interest rates are perceived (note that i am using the word “perceived”) to be headwind for growth stocks. Some argued that the higher interest rates will discount future cashflow at a higher rate, thus negatively impacting current valuation of growth stocks. Later in this article, I will share past data to counter this belief.
Geopolitical tension between Russia and Ukraine contributed negatively to the already unstable/ fearful market.
Let’s take a look at some historical data on such corrections in the market!
The average Nasdaq Composite correction since the Financial Crisis is 52 days, with a 15.2% decline. In the last correction that started in February 2021, the index fell 10.5% in just 24 days (refer to table below).
Based on the current level of corrections on the NASDAQ which is 14.7%, its close to the average of 15.2% post GFC and higher than the median of 12% post GFC.
No one knows!
No one can claim that they can foresee the future. In the past instances, we see many “experts/ gurus” claiming this and that, but with the benefits of hindsights, we know the market didn’t turn out what they said will happen (refer to table below). Of course I don’t claim to have a crystal ball as well and I may be wrong. Most of the time, I like to use past historical data to provide some guidance in my investment journey to increase the probability of winning. Remember; no market crisis are the same, but the human behaviour during these crisis remains the same throughout history; fear and euphoria.
What’s the odds?
Again, i will be using historical data for the purpose of analysing whether it will be a good time to add capital to the market, especially towards growth stocks, since they are having one of worst correction since Covid started.
1. Past FED Hike Cycle
- U.S. Stocks Historically Deliver Strong Gains in Fed Hike Cycles.
- A growing economy tends to support corporate profit growth and the stock market.
- Stocks have risen at an average annualized rate of 9% during the 12 Fed rate hike cycles since the 1950s and delivered positive returns in 11 of those instances
- Strategists project that the S&P 500 will finish 2022 at 4,982.
- Personal target for S&P500 stands at 5,115 (based on historical data trajectory). Last year, my target was 4,650 which was pretty close (closed 4,778 or 2.75% higher compared to my forecast made in January 2021).
2. Past Corrections on the S&P500
Will 2022 be a negative year for the market? Since the turn of the century, the S&P has only seen five negative years out of twenty-two years. That’s a probability of 22.7%. The S&P started the year at 4,778 and thus, the probability of the index ending below this level is close to 22.7% based on history.
But from the above table, we see that during a particular year, there are opportunities for investors to buy cheaper (look at the intra-year decline). Let’s take 2009 as an example, intra-year decline was 27.2% but the S&P500 closed the year 26.5% higher. Factoring that, if an investor bought the index during the intra-year lows, he will be making more than the annual return and in the above case, higher than 26.5%. Most probably the investor will be gaining a whopping 53.7% (26.5% + 27.2%) for the year 2009.
3. Past Corrections on the NASDAQ
Post GFC, the NASDAQ saw 13 corrections (10% and above) and the current one is the 14th. Out of the past 13th corrections, NONE (0) of them turned out negative 6 months or one year after it entered correction level (10% or more).
This is a piece of very strong statistics pointing to the fact that if we take a position on the NASDAQ now (in correction territory), 6-12 months down the road, we will most probably be positive. From the science of probability, using data since GFC, the probability of winning if the position is taken now is actually 100%. Of course again, no one knows. But based on statistics and probability, and the risk-reward matrix, it makes really good sense though.
4. Behavioural Science of the Market
Investors behaviour during past bust and boom periods has relatively remained the same, though we have gone through many crisis. Why is this so? Market participants change over the years and it is difficult to manage one’s emotion, how much more the entire market emotions.
One thing stayed constant, that the market has this tendency to over-price both risks and opportunities, thus you have extreme fear on one end and extreme euphoria on the other. Investors find it easy to buy when everything is rosy (buying high) but when the market is extremely fearful (discounts in the market), they hesitated to take up any new positions; instead selling into the weak market (selling low). Thus, if you ask around, most people will tell you that they are losing money investing.
In our actual life, we wait for sales to buy the items that we need or want. And when things are getting expensive, we tighten our belts. This is exactly the opposite of what we are doing for our investment. Why is this so? It is due to our emotions and we choose to be guided by them while investing, instead of using science, data and information to analyse logically.
5. Is there a strong relationship between FED interest rates and stock market performance?
Based on the above chart, we don’t see a close co-relationship between market performance and the 10-year Treasury yields. There are instances when the yield spiked but both the S&P500 and NASDAQ rallied (Year 2016, 2018, 2021) and the reverse (Year 2018 and year 2020). This time round, we are seeing the yield spiking and both S&P500 and NASDAQ pulling back. One factor that is different now compared to the past years is inflation numbers. We are seeing the market moving against the norm here. If you are believing that the inflation numbers will eventually come down in the second half of the year, we should see them returning back to norm towards the second half of the year.
6. Past U.S. Midterm Election Year
The US midterm election will be happening in November 2022. Investors will be closely watching this event toward the end of the years. What is history telling us?
- Since 1950, the S&P 500 has averaged an intra-year pullback of 17.1% in midterm years.
- But the final three months of a midterm year and the first two quarters of the following year, known as the pre-election year, have been some of the strongest quarters for stocks over the four-year U.S. presidential cycle.
With the above information, the odds looks pretty good if you have an investment horizon of 2 years and above. ALL post mid-term election years registered positive returns, though we see some hefty pullbacks on the market during the course of the year (which we are having one currently). Investors would need to manage their expected investment return for 2022. We should not expect to perform like 2020-2021.
Conclusion
Based on the 6 factors shared above, it seems very logical to me to buy into the dips now. The probability of positions taken now and holding them for the next 1-2 years resulting in profits is pretty high. The risk-reward is encouraging. Of course, I would like to say again, nobody knows and I am just trying to forecast the future of the market using past historical data. For me, I have already started nibbling, buying in small quantity to spread the risks over the past two week.
Personally, investment to me is not momentarily, but a lifestyle, a habit, something over the course of my life (long term). Take emotions out of your investment decisions and change your mindset. This kind of market condition gives us an opportunity to train ourselves, to do the opposite of what we used to do (buying high and selling low). Start practising and soon, you will find it easier to manage your emotions when it comes to making investment decisions.
I would like to end with a famous quote by Warren Buffet. Wishing you a happy Chinese New Year and a 2022 filled with an abundance of all good things. Profitable investing!
