After the stock market had its worst year since 2008 last year, there's one question on most investors' minds: Has the stock market hit bottom yet?
It's easy to see why investors would want to know. After an epic rally from the pandemic bottom in March 2020 sent stocks soaring, the bear market that started last year killed the party. Stretched valuations in the tech sector and high inflation set the market up for a pullback as the Federal Reserve ramped up interest rates to bring inflation under control. Rising interest rates led to falling valuations in the stock market and encouraged investors to move money into the bond market as treasury yields topped 4%.
Last year, the S&P 500 (^GSPC +1.20%) fell 19%. And from peak to trough, the index saw an even bigger decline of 28%, though it's already bounced off the lows seen back in October with an 11% gain. Even with that rebound, it's easy to see why investors still want to know if the market has bottomed or not.
Most economists still expect a recession in 2023, and corporate profits are estimated to have declined last quarter (earnings season has just begun). Beyond that uncertain outlook, there's another reason why investors are apprehensive about the market bottom. That's loss aversion, a psychological concept that means investors would rather avoid losses than make gains of the same size. In fact, according to research, the psychological impact of losses is twice that of gains. Investing in a bear market, therefore, means risking losses and facing loss aversion in a way that doesn't occur when investing during a bull market.
Naturally, every investor would like to be able to time the market, but it's impossible to do so consistently, and the greatest investors, like Warren Buffett, don't waste their time or energy trying to do so.
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A better question to ask
Rather than wondering if the market has bottomed, or trying to determine when it will happen, investors are better off revisiting their investing goals. That means asking yourself what your time horizon is and what you are investing for.
If you're investing for a retirement that's at least several years away, you're better off ignoring the market volatility and continuing to invest at regular intervals. After all, if you are saving for retirement, you're a net buyer of stocks, and you should remember that market pullbacks are actually good for net buyers of stocks as they make stocks cheaper.
If you're hesitant to buy stocks in a downturn, it's also worth remembering that missing out on the recovery could be a much bigger mistake than investing before the market bottoms.
How to protect yourself from a downturn
If on the other hand, you have a shorter time horizon, or you're already in retirement and living off your savings, you may want to consider investing in lower-risk assets such as dividend-paying stocks and bonds. These options will do a better of protecting your wealth from a sell-off.
Investors concerned about the direction of the market should pay attention to macroeconomic data around inflation and interest rates. Last year's market sell-off was primarily driven by the Fed's decision to raise interest rates to rein in inflation, and the market generally expects stocks to recover as inflation comes down and the Fed stops hiking rates.
When that happens will be determined by a variety of factors, including the inflation rate, market-based interest rates like treasuries and mortgages, as well as general economic data around the labor market, retail sales, and GDP. Additionally, earnings results and guidance will also influence the market's direction.
The good news is that inflation has started to come down, and there are other signs the economy could get a "soft landing." Ultimately, no one knows for sure if the stock market has bottomed, but most investors are better off ignoring that question and preparing for the recovery by taking advantage of the sell-off.
