Don’t Fight the Fed, But That Goes Both Ways

Among stock market analysts, opinion is becoming nearly unanimous that the market has not yet found a bottom. Since the S&P 500 began to decline at the beginning of the year we have seen four substantial bounces, averaging 9%, the most recent one being the rally from 5/12-6/2. Each of these bounces have resulted in the S&P 500 revisiting its prior low or making new lows. This price action is frequently referred to as a bear market rally. Bear market rallies are frequently swift and violent—think of it as a market correction in reverse that occurs during bull markets.

Timing the market can have many negative unintended consequences, namely getting out of the market too late and getting back in too late. When financial advisors remind clients that the key to prosperous investing is “time in the market not timing the market” it is a warning against this type of negative consequence. For the most part I agree with this logic because I believe that without a systematic process market timing will nearly always lead to sub-par results. However, when I hear analysts and advisors back up this logic with the reasoning why timing doesn’t work is that 80% of the markets overall gains took place during the course of 50 trading days, I have to question that reasoning. Statistically speaking they are correct: since 1993 the S&P 500 has gained 1512%, of which the compounded growth rate of the top 50 trading days equals 1215%. However, of those 50 trading days a full 30 of them took place while the S&P 500 was in a bear market. Again, bear market rallies are swift and violent. In fact, looking at the top 10 daily market gains for the S&P 500, all of them took place during a bear market. In all but 3 of these instances the result was future lower lows. The point is, don’t read too much into so-called relief rallies.

The technical definition of a bear market is one in which the index has fallen 20% or more from market peak to bottom. On a closing price basis, the S&P 500 has yet to confirm a bear market. It came close on May 20^th before a late day rally took the index back above bear market territory. That being said, I believe that what we have here already qualifies as a bear market. In 2020, the last technical bear market, peak to trough occurred in a one-month period, and full recovery took a grand total of 6 months from prior peak. Currently, the market has been underwater for 5 months and barring a remarkable turn of events it will spend at least another few months submerged.

Over the past 13 years investors have gotten acclimated to the prospect of swift market recoveries. Much of this faith has been rewarded, whether the investor knew it or not, by accommodating Federal Reserve policy. The mantra, “Don’t fight the Fed,” has been the bulls rallying cry since the end of the Financial Crisis and for good reason, it’s wise not to bet against a “trader” who also possesses a printing press. That mantra is as equally applicable today as it was in March 2020, but the Fed you shouldn’t fight is a Fed determined to bring down inflation.

Inflation remains the biggest bogey for the market. While some market participants may doubt the Fed’s resolve to let the market fall, as long as inflation stays elevated their hands are tied. The next Consumer Price Index report is due out next Friday, and while the market will certainly react strongly to it whatever way it reads, I am more focused on rising energy costs. WTI Crude Oil gained nearly 3.5% this week, while Gasoline futures added over 6.5%. As long as energy prices continue to rise the cost of all goods and services must also rise. The Fed has given investors quite a lot during the last 12 years, but now it feels like the proverbial chickens are coming home to roost.

Thanks for reading,

Zach and Dave

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