At the time of this writing, the Nasdaq Composite is down 28% from its all-time high while the S&P 500 is on the cusp of entering a bear market.
2022 has been a brutal year for investors. It's one thing for a small unproven company to see its stock plummet, but it's quite another for an industry-leading giant like Amazon to see 40% of its value evaporate in a matter of months.
No one likes losing money. And as hard as it is to see the bright side in a bear market -- there are valid reasons why it could be a good thing. Here are a few.
Past bear markets
I can't speak to the dot-com bubble burst from personal experience, but I can say today's bear market feels less scary and more reasonable than any other bear market in the last 15 years. During the financial crisis for example, no one knew when the bailouts were coming, whether they would even help, and how much the individual taxpayer would be affected by such a catastrophic collapse. The depths of the financial crisis were by no means an easy buying opportunity.
The same goes for the fall 2018 bear market. The U.S.-China trade war was escalating, and at the time, the Federal Reserve's monetary policy was hawkish and didn't support lower interest rates. During the worst of the crash, there seemed to be no end in sight, and a long-term impact on global trade was in the cards.
The pandemic-induced bear market was also a difficult buying opportunity. Global lockdowns disrupted our way of life and doing business. It was unclear whether U.S. federal and monetary policies would be enough to lift the economy out of a recession. And finally, many leaders, businesses, and consumers were unprepared for COVID-19.
A reasonable sell-off
The situation in 2022 doesn't seem nearly as scary as those other bear markets. In fact, it's reasonable and could even be healthy for long-term investors. The S&P 500 doubled between 2019 and the end of 2021, despite the backdrop of the pandemic and how the economy remained in worse shape post-COVID than before it.
An increased consumer savings rate during the pandemic and delayed spending, paired with supply chain disruptions and a lower supply of raw materials and commodities, has led to a supply/demand imbalance. The result has been rising prices, which has led to inflation. Low interest rates contributed to artificially higher demand for consumer goods and homes, which also inflated prices.
To combat inflation, the Federal Reserve is effectively reducing demand, because it can't control supply. And the best way to do that is to raise interest rates, which makes money more expensive and leads to lower growth.
Therefore, the short-term outlook for the stock market is bleak, and valuations have compressed accordingly. This isn't to say excellent companies deserve to be worth 50% less today than they were just a few months ago. However, if we are going to endure a stock market sell-off, we at least want it to make sense, and to some extent, this one does.
The coiled spring
The good news is this weakness is grounded in short-term fears, presenting an excellent buying opportunity. If the economy slows simply because of an economic cycle of rising interest rates, that doesn't affect the long-term investment thesis for many companies.
One of the reasons we saw such swift rebounds after the fall 2018 bear market and the spring 2020 crash is because investors determined the sell-off would be short-lived, and the Federal Reserve would do its part to support the economy. That assumption was a gamble considering we didn't know the extent of the trade war or how long the pandemic would last. Today, it seems likely the Federal Reserve will have to keep raising interest rates until inflation is under control.
Hypothetically speaking, if we could hit a pause button on the economy for just one year, that would give time for supply to catch up with demand and could tee up a coiled spring for a multi-year period of growth. Put another way, this recession may be exactly what is needed to set the stage for the next bull market.
Meanwhile, worker productivity has skyrocketed, and unemployment is 3.6% -- one of the lowest readings in 60 years. The fact more people are working and household income is high heading into a potential recession should help cushion the blow.
The macroeconomic discussion gets a lot of attention these days, but little has changed for major long-term trends such as e-commerce, the war on cash, renewable energy, and cloud infrastructure. These fields seem poised to grow long term, and businesses riding these trends present some compelling buys -- especially for investors who felt like they missed the boat as valuations surged over the last few years.
A great time to buy
Despite the silver lining I've presented above, it's still never easy to be a buyer in a volatile market. Bear markets present swift and severe drawdowns in equity valuations, and it can take years for stocks to recover. Some never do.
Therefore, investors may find it best to stick with industry-leading companies they can count on. This approach probably won't produce the biggest gains, but it offers a risk/reward balance that makes sense for most investors.