How Long Will the Positive Market Last?
Will the Stock Market React to Everything that’s Going On?
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If you look at the movement of the stock market, you would assume everything in the financial world is rosy, but if you ask people how they feel financially, you might get a different picture altogether. There is often a disconnect between people’s lived experience and how the stock market performs, and the divergence seems particularly great at the moment. Increases in the prices of everything from food to gasoline have stretched family’s budgets and caused lots of personal economic pain, but at the same time, stock indexes continue to reach all-time highs. Whether your outlook is more dependent on how you are able to manage day-to-day or you are considering how your investment portfolio is positioned to help take care of you in the future, a natural question to ask is whether the strong run of the stock market will continue on the path it has been on or if we will see the inevitable pullback occur in the near future. Of course, nobody has a crystal ball to predict the future with any level of accuracy, so speculation on what is likely to happen in the near term is just that, speculation. However, if we look back over past history, we can see some common factors that have caused the stock market to reverse course from positive to negative, so we want to explore that further in this edition of the newsletter to establish some expectations of what may be to come in the investment world.
Factor #1 – Economic Downturns
While the broader economy and the stock market do not perform in lockstep, what happens in the economy often will eventually affect the companies that make up the stock market, so an economic downturn can ultimately result in a pullback in the stock market. There are many factors that can cause an economic downturn, but they often are linked to either jobs, price inflation, or both. The Federal Reserve (the Fed) is responsible for trying to keep the U.S. economy at as close to full employment as possible, while also keeping inflation at a reasonable level. They have a few levers they can pull to accomplish those goals, including controlling the supply of money and influencing the level of interest rates. After beginning to lower interest rates to lower inflation that increased post-pandemic, the Fed has more recently slowed their trend towards lower interest rates because of other factors that have caused inflation to tick back up again. A recent jobs report came out stronger than expected, although the job market is still under strain as employers seek to manage their costs in an environment where tariffs have increased their cost of doing business. Whether it comes in the form of a technical recession, which is two consecutive quarters of decreased economic growth, or just a slowdown in the economy, there is currently pressure on the economy due to the status of jobs and rising prices. A factor that has been aiding the stock market is the way artificial intelligence (AI) has permeated society and created higher levels of efficiency for organizations. If the price and job trends continue, even with advances in AI, the stock market may eventually feel the pinch. If and when that could translate to stock prices is anybody’s guess.
Factor #2 – Market Bubbles
A stock market bubble occurs when stock prices rise in such a way that they are not representative of the fundamental value of the companies that make up the market. Bubbles tend to be driven by unrealistic expectations of investors who are concerned that they are missing out on a wave that could boost their portfolio value. Because valuations are not indicative of real value, there often comes a point at which it becomes evident that valuations are not supported by evidence, which can result in investors selling their positions, which can eventually cause panic selling, during which time the bubble begins to burst. In recent years, much of the stock market’s growth has come from a very limited number of companies, many of which are in the AI space. Some would say that the increase in market valuations is unsupported by the fundamentals and that there is an AI bubble that is ripe to burst. Others would say that this technology is integral to the way the future is going and that the valuations are reasonable. Only time will tell whether the trend is sustainable or it is actually a bubble. One of the challenges with market bubbles is that you can’t necessarily tell whether it is a bubble or not until after the bubble has burst.
Factor #3 – Unexpected Events
One of the hallmarks of sustained positive stock market performance is that it desires a decent amount of predictability. Even if there is bad news, if the bad news is expected, the market tends to price that in and move forward. It is when things go off script that the markets often tend to become more volatile. In that light, unexpected events, especially ones that are widespread can cause the stock market to behave negatively, even if that behavior is only temporary. A good example of this would be the COVID-19 pandemic. The world had not seen such an event in over a century, and the speed with which it took hold caught the markets off guard, and the drastic nature of shutdowns created chaos in society and in the markets. However, after it became more evident that solutions were on the way to improve the situation, the markets bounced back, and within less than a year, stock indexes had recovered from the initial corrections that occurred. In today’s world, we are dealing with the war in Iran that few would have predicted 6 months ago, and not only has the location of the conflict affected oil and gas prices negatively, the uncertainty around how long the war will last and its longer term consequences have been a challenge. For the most part, the stock market has continued rolling along despite the ongoing nature of the war, but it remains to be seen how long that will continue.
Factor #4 – Breakdown of Systems
In generations past, it may have taken time for the fallout from incidents that occurred to result in a stock market reaction. However, with the speed of information travel now and the systems that are in place, reactions can happen much more rapidly. Take the bank failures that kicked off the Global Financial Crisis in 2008 as an example. There were indications before 2008 that there were structural problems at play, but once the failure of Lehman Brothers occurred, a second investment bank failure in 6 months, there was a serious chain reaction that followed, and it resulted in a bear market that saw the S&P 500 index decline over 40% in less than 6 months. Technology has only intensified the possibility of these types of situations being worse. A signal that excessive selling is happening can trigger algorithms to amplify the effect of the selling, even if there is no rationale for it.
If you are keeping score at home, there are elements of each of the factors we can point to presently. Does that mean a market downturn is imminent? Not necessarily. Could it happen? Sure. The fact is that stock market behavior is impossible to predict, so it is a good idea to have a defined investment strategy in place that is more aligned with your personal circumstances and objectives rather than market forces that you cannot control. Those circumstances and objectives may mean that you should reduce your exposure to the risks of the market, but they may mean that even if a rough patch occurs, you can afford to ride it out. There is no substitute for a strategy that can help you have a basis for the moves that you do or don’t make. In these uncertain times, be sure you have such a strategy in place for yourself.
Stewardship Emphasis
Conventional wisdom is good to follow until it isn’t. It is always better to do your own due diligence and make decisions based on what you know rather than what the crowd is doing.
The Empowerment Channel | Volume CCL | Dedicated to Promoting Financial Educationthrough Stewardship