It has been an absolutely abysmal year for stocks. The S&P 500, a broader benchmark for the market, is down more than 22% with just under three months to go in 2022.
The outlook for the economy and the market is also quite murky. Investors are still trying to understand if there will be a more severe recession next year and how the Federal Reserve might progress with interest rate hikes.
There's also another big unknown for stocks when thinking about how quantitative tightening, which is when the Fed reduces its balance sheet and effectively pulls liquidity out of the economy, will continue to affect stocks. With so much uncertainty, is it safe to invest in the stock market right now?
It's OK to be fearful right now
In today's market, it's certainly OK and even wise in some respects to be fearful and respect the fact that we are in turbulent times. The Fed has embarked on one of the most aggressive rate-hiking campaigns in decades, and many of those hikes only began in June, so their full effect really hasn't been felt yet.
Image source: Getty Images.
That's why so many investors are concerned about a deep recession in the near future. Eventually, consumers and businesses are going to be dealing with a higher cost of debt on their mortgages, student loans (many of which haven't been paid down in more than two years), and revolving lines of credit. Furthermore, inflation has reduced the personal savings rate in the U.S. and people are definitely starting to feel the sting, which could drain their savings and make covering their debt payments harder. Unemployment is also expected to tick higher in the near term, which could put further strain on consumer finances and the economy.
This would have a sobering effect on business activity, which could see falling demand that would hurt sales and likely lead to lower earnings for corporations. Earnings estimates for many companies in the S&P 500 are likely still too high right now. As I mentioned above, quantitative tightening could also cause unforeseen issues -- in 2019 it led to yields in the repo market spiking, and the Fed had to inject cash back into the system.
But you can also be opportunistic
While you should be aware of the uncertainty and the risk factors in the environment, I also don't think that should discourage investors from investing right now, as long as they take a long-term approach and do their due diligence.
After all, legendary investor Warren Buffett says that investors should be "fearful when others are greedy, and greedy when others are fearful." Buffett's company, the conglomerate Berkshire Hathaway, has certainly backed this ideology up by plowing more than $57 billion into equities through the first six months of the year.
History tells us that over the long haul, you are more likely to make money on your stocks than lose it. Between 1928 and the end of 2021, the S&P 500 generated an average annualized return of more than 11.8%.
What to buy in this market?
I do not recommend trying to be a hero in this kind of market, where investors are really weeding out the companies that try for growth at all costs and don't think about a clear path to profitability. I also can't reiterate enough how important a long-term view is right now because of the possibility of a more severe recession in the near term.
You want to invest in companies that have a fortress balance sheet and can cover their debt payments, while also being able to absorb shocks in more brutal economic conditions. Thinking about businesses that can operate effectively in a more severe recession is a good idea as well. Two stocks that come to mind that meet this criterion are Bank of America and Microsoft.
Finally, I like to look at valuations and am more apt to buy stocks with reasonable valuations, or ones that might even be historically low. I find this makes it easier to evaluate a stock and can lead to more upside. Sure, a stock with a higher valuation may have better growth prospects ahead, but it leaves less room for error, and investors don't need a big reason to sell in this market.
Luckily, most valuations have come down at this point, but I would not buy any stock trading at 50 or 60 times revenue, as many investors were more willing to do last year.
