Investing hasn't felt very fun over the past few months. Many stocks are down significantly from their highs of 2020 and 2021, especially riskier investments. It's a symptom of an overall sinking market; the S&P 500 is down more than 17% from its high today.
You've probably heard nuggets of wisdom, like being fearful when others are greedy and greedy when others are fearful. But when banks are failing, recession talk is everywhere, and geopolitical tensions are stressing folks out, does that mean you should be scooping up shares of all your favorite stocks?
Not so fast. Pump the brakes and consider this -- I'll show you where this market's decline stands in history, and what could be the best way to play it moving forward.
Our descent might not be done yet
Let's get one thing straight: I don't know when the market will bottom. Nobody does. Run away if someone claims with certainty they know. However, you can look at the evidence for clues about what could happen, and there are signs that the S&P 500 isn't done heading lower.
Below, you'll see every significant drawdown by the S&P 500 over the past six or seven decades. There have been some painful market crashes throughout history; some that come to mind might be the Great Recession in 2008-2009 or Black Monday in 1987. The market, by broad definition, entered a bear market last year, but it's still relatively minor compared to plenty of instances over the years.
You've probably heard about inflation -- the prices of seemingly everything have soared over the past couple of years. To combat this, the Federal Reserve can set policies (such as raising interest rates) to influence the economy. The M2 Money Supply is essentially the amount of money circulating in the U.S. economy (measured as cash, money in checking and savings accounts, and CDs).
U.S. M2 Money Supply data by YCharts
Inflation has been the worst in several decades, and the Fed responded by aggressively pulling back on the money supply in the economy. This has some to do with the turbulence in the banking system you're seeing today. You can see above that the drawdown in the monetary supply is its sharpest in recent history.
Many economists fear that this sharp pullback will trigger a recession. Research firm The Conference Board estimated a 99% probability that the U.S. would enter a recession within the next 12 months. A recession will hurt companies' growth and earnings and could put further pressure on the broader stock market.
How to prepare for more market volatility
Sometimes the market zigs when everyone thinks it will zag. However, it seems that the economy could struggle over the next several quarters. But this isn't to scare you but to prepare you. Bear markets have historically been great buying opportunities for long-term investors, and that can prove true again -- but you've got to be smart.
Manage your risk. A recession can hurt growth and make raising money harder for less-established businesses. Are you a growth investor? Make sure the companies you invest in are profitable (at least producing positive cash flow) or have enough cash on their balance sheet to fund the business for several quarters.
Are dividend stocks your specialty? Know whether your investments are in cyclical companies that can struggle in a recession. If they are, a healthy balance sheet will help them endure the down times and survive until the good times return. A healthy dividend payout ratio can also add a layer of peace of mind to your dividend portfolio.
Recessions can be a great buying opportunity, but you need to stay in the game to prosper later. Protect your portfolio from unnecessary risk, and focus more on the companies you own than what the broader market might do on a day-to-day basis.
