The stock market had a rather bumpy start in 2022. In fact, the performance during the first half of the year has been reported as one of the worst in many decades.
The S&P 500 is often used as a benchmark for tracking overall equity investing performance. And the index has so far stumbled by 10% year to date, with a 21% drop in the first six months.
The 993-point drop has many market analysts and brokers thinking that 2022 will be one of the worst-performing years since the financial crisis. And a similar story is emerging for the London Stock Exchange when looking at the FTSE 250.
But what exactly is going on? Why is the stock market down? And when might it recover?
Why has the stock market dropped?
There are undoubtedly a lot of contributing factors to the disappointing performance seen so far this year. However, one primary catalyst seems to be related to the state of the economy. Following the mass issuance of stimulus cheques in 2020, along with supply chain disruptions, inflation has gotten a little out of hand.
To combat the devaluation of money, central banks like the Federal Reserve in the United States and the Bank of England here in the United Kingdom have begun raising interest rates. The idea is to deliberately slow down the economy to let inflation cool off.
But that’s easier said than done. And suppose the new monetary policy was too aggressive. In that case, it could land send economies into a new recession, placing even more pressure on consumer spending and business earnings alike. And with the Bank of England predicting a recession is likely, investor fear is rightfully at a record high.
Consequently, with uncertainty on the rise, along with panicking investors, stock prices have been slashed, triggering a bear market. And given the high-flying valuations that growth shares saw in 2021, the stock market’s downward trajectory has only been amplified.
What happens during a crash or correction?
A stock market crash has no fixed definition. But most usually use the term to describe a period of rapid double-digit decline in share prices. A stock market correction is similar, except the decline occurs over the course of several weeks and months. Therefore the market volatility seen in 2022 is better described as a correction.
Every crash and correction throughout history has been triggered by unique circumstances. However, regardless of the initial trigger, there’s a consistent trajectory of what happens next.
The initial decline is usually triggered by an economic growth issue that causes panic triggering fearful investors to start dumping their stocks. This then causes more investors to panic, resulting in a spiral of losses. In reality, this is almost always a bad investment decision because it tends to result in high-quality companies being sold at low prices.
Eventually, fear begins to die down. And as the original problem that started the mess is resolved, investor sentiment starts to improve. With high-quality businesses able to survive the storm, growth soon returns to the picture. And with it, the stock market begins its recovery before likely reaching a new all-time high.
That’s why, for my portfolio, I hold onto my positions, even as they fall. And look for opportunities to buy them at a discount before the recovery process begins.
How long before the stock market recovers?
It’s difficult to know exactly when a stock market recovery will begin. In fact, it may have already started.
There are still lots of concerns about the level of rising inflation and the risk of a recession. And it’s also possible that the downward trajectory may continue for quite some time.
However, analysts at JP Morgan have issued forecasts suggesting that the losses seen in 2022 will reverse by the end of the year. If this is accurate, then it suggests that the stock market will recover in the coming months before resuming growth in 2023.
Whether this will actually happen, only time will tell. But with commodity prices beginning to tumble, it suggests that the current monetary policy is having the desired effect of reversing inflation. And therefore, I’m cautiously optimistic about the future.
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Saima Naveed does not own shares in any of the companies mentioned. The Money Cog has no position in any of the companies mentioned. Views expressed on the companies and assets mentioned in this article are those of the writer and, therefore, may differ from the opinions of analysts in The Money Cog Premium services.