What a difference a year makes! Last year featured minimal stock market volatility, with the broad-based S&P 500 (^GSPC 1.29%) retracing no more than 5% at its peak. In 2022, all three major indexes have plummeted into a bear market, with the ageless Dow Jones Industrial Average (^DJI 0.73%), S&P 500, and growth-focused Nasdaq Composite (^IXIC 1.79%) plunging by as much as 22%, 28%, and 38%, respectively, from their all-time highs.
On one hand, double-digit percentage declines in the stock market have always represented a buying opportunity for patient investors. Nevertheless, it can be trying on investors -- especially newer investors -- to deal with wild bear market price swings. It rightly has people wondering when and where the bear market will bottom.
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Here's why investors are closely monitoring the Fed's moves
Some investors believe the Federal Reserve's monetary policy can act as a surefire indicator of a stock market bottom.
With the U.S. inflation rate rocketing to a more than four-decade high of 9.1% in June 2022, the nation's central bank has had no choice but to raise its federal funds target rate at the most aggressive pace in decades. As interest rates climb, access to cheap capital and borrowing demand should taper off. In other words, the Fed is purposely hitting the brakes on the U.S. economy to tame high inflation.
The thinking for a select group of investors is that a Fed pivot from hawkish to dovish monetary policy could signal a green light to pile back into equities. If interest rates were to level off or begin to fall, it would, in theory, indicate the Fed's intent to reignite economic growth, especially among high-growth companies.
However, the nation's central bank doesn't appear to be anywhere close to letting its foot off the accelerator. As of Sept. 21, the central tendency projection (i.e., the consensus forecast excluding the three highest and three lowest projections for a given year) for the federal funds rate is 4.4% to 4.9% in 2023 and 4.1% to 4.4% to end 2022. For context, the federal funds target rate is at 3% to 3.25% right now. This would imply a strong likelihood of a 75-basis-point rate hike in November, and at least another 75 to 100 basis points of future aggregate hikes before the Fed would even think about rate cuts, which are currently forecast to occur in 2024.
Don't expect a quick stock market bottom if the central bank changes its tune
Although rate easing is almost always viewed as a positive for equities, the Federal Reserve has a habit of reacting to economic variables rather than proactively anticipating them. Put another way, it's usually late to the party when it comes to adjusting interest rates higher or lower. The runaway inflation we've experienced this year on the heels of historically low lending rates and a lengthy period of quantitative easing (bond and mortgage-backed security buying) is a testament to this fact.
Effective Federal Funds Rate data by YCharts.
Since this century began, investors have navigated their way through four bear markets, including the current one. In each of the three previous bear markets, it took a long time for the stock market to bottom out after the central bank enacted the first rate cut of an easing cycle.
- Less than a year into the dot-com bubble bursting, on Jan. 3, 2001, the Fed began an easing cycle that would see the federal funds rate move from 6.5% to 1.75% in about 11 months. However, it took until Oct. 9, 2002, before the stock market reached its nadir. That's a 645-calendar-day wait from initial decrease to actual bottom.
- As the financial crisis began to take shape, the nation's central bank reduced the federal funds rate from 5.25% to an eventual range of 0%-0.25%. Though this rate-cutting began on Sept. 18, 2007, the stock market didn't bottom out until March 9, 2009, or 538 calendar days later.
- The Fed, once again, began cutting its federal funds target rate on July 31, 2019, with this easing cycle taking rates from a range of 2%-2.25% back to 0%-0.25%. With the coronavirus crash hitting its bottom on March 23, 2020, we're talking about a 236-calendar-day difference between initial rate cut and actual market bottom.
To be clear, there is no such thing as a foolproof indicator or metric that accurately predicts when bear markets will occur or precisely where they'll bottom. But the data here clearly shows that Federal Reserve rate cuts aren't a good predictor of stock market bottoms. Given that it usually takes multiple quarters for rate changes to have tangible impacts on the U.S. economy, it makes sense that most market bottoms occur much later.
If the current federal funds rate forecast holds true and history repeats itself, a stock market bottom may not be in the cards until late 2024 or well into 2025.
Image source: Getty Images.
Here's why buying stocks now makes sense (even if a bottom could be years away)
Admittedly, this probably isn't the data you wanted to hear. But as noted, no indicator or metric is foolproof when it comes to calling stock market bottoms.
There is, however, one practical guarantee offered by Wall Street, and all it requires is the patience of investors.
For quite some time, market analytics firm Crestmont Research has been publishing the rolling 20-year total returns, including dividends paid, of the S&P 500. For example, the rolling 20-year total return for 1936 would include years 1917 through 1936 and account for all dividends paid. This total return is then averaged out over 20 years by Crestmont and expressed as an average annual total return.
Crestmont has used its tools to analyze 103 individual rolling 20-year periods from 1919 through 2021. Its data shows that every single 20-year rolling period produced a positive total return. The key point being that timing the market matters far, far less than time in the market. If you were to buy and hold an S&P 500 tracking index for 20 years, it's been a practical guarantee that you'll make money.
Even though a laundry list of indicators and metrics suggest the stock market is nowhere near a bottom, adding high-quality companies during the current bear market decline is a smart move for long-term investors.
