For years, the adage “Don’t fight the Fed” meant only one thing: buy stocks. Now, legions of newbie investors who’ve never had to face inflation before are learning it can mean something else, too.
Battered for months by hawkish pronouncements by Jerome Powell, a man investors once considered their staunchest ally, the S&P 500 finished Monday more than 20% below its last record close, ending a two-year bull run that was among the most powerful ever recorded.
That Powell’s Fed should end up being the selloff’s star villain is bitter medicine for people who thought they had the market figured out. A booming economy, strong earnings estimates and still-flush consumers weren’t enough for stocks bulls to overcome red-hot inflation and a Fed chair hellbent on tamping it down.
The drop has been brutal for freshly christened equity enthusiasts once armed with government stimulus checks and urged to bet them long, often by online impresarios and other new-wave advice givers. Turns out, investing remains risky business, particularly when central bankers change course.
“The Fed put is a wing and a prayer at this point,” Victoria Greene, chief investment officer at G Squared Private Wealth, said by phone. “Investors should prepare for more pain.”
The S&P 500 fell 3.9% Monday after a ninth weekly decline in 10, becoming the latest benchmark to endure a drop of at least 20%. The Russell 2000 of small-caps entered a bear market in January, while the tech-heavy Nasdaq 100 did so two months later.
The decline makes Jan. 3 the end to what was in many aspects an unprecedented bull market for the S&P 500. At 651 days from its start March 23, 2020, this one was the shortest on record. Yet what it lacked in duration, it made up for in velocity. Its 53% annualized gains over the stretch were the biggest ever.
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And its bounty is far from depleted. Anyone lucky enough to have purchased stocks at the pandemic bottom is still — even after Monday’s beatdown — sitting on a gain that annualizes to almost 30%, while over the past three and five years the return is above 11%.
You can get a sense of an era’s flavor from the people it made famous. In the dot-com bubble, securities industry gurus like Henry Blodget and Jack Grubman earned regulatory scorn for their role putting a professional veneer on what turned into a brutal reckoning for speculators. In the latest trip up, it wasn’t Wall Street analysts but do-it-yourself tastemakers on social media who did most of the cheering.
Much of that rally owes to the Fed itself, which rushed to the rescue in March 2020 after the pandemic forced shutdowns that throttled the economy. Government stimulus paid directly to households soon followed, flooding the market with cash in a rarely seen joint easing.
Armed with free dollars and stuck at home with no sports to bet on, many Americans turned to the stock market, urged on by social-media stars like Barstool Sports’ Dave Portnoy, who insisted that stocks never go down.
Retail mania culminated in January 2021, when a dizzying rally in GameStop Corp. captured the country’s attention, making a star of Keith Gill, the trader known as “Roaring Kitty.” Day traders went on to frantically bid up a wide range of fringe, oddball stocks in what became one of the greatest euphoric episodes in recent history.
“The ones who came in at the height of this as money was easy, as liquidity was abundant — it’s got to be brutal for them,” Quincy Krosby, chief equity strategist at LPL Financial, said by phone. “The market is very much like mother nature. Just when you think you understand mother nature you get hit by a major snowstorm. This is the market at work.”
The same stimulus, the last round of which passed in spring 2021, and Fed largesse bear some of the blame for the surge in inflation that’s now forced the central bank to go full bore in its battle to tame it. Its new role as market antagonist is unfamiliar to a generation of investors who have only endured short pullbacks.
Now that interest rates are rising, equity valuations that in some cases approached dot-com levels no longer make sense. With the S&P 500’s price-earnings ratio dropping from 25 in January to 19 Monday, the multiple contraction has accounted for the entire plunge in equity prices.
Companies like Bed Bath & Beyond Inc. and AMC Entertainment Holdings Inc. that had little or no earnings had no trouble surging in the meme era of easy money. Now they are crashing. In many parts of the market, from unprofitable technology firms to newly public stocks, losses exceed 60% from 2021 peaks.
Cathie Wood’s ARK Innovation ETF, is one notable victim. The fund, which surged 149% in 2020 alone, is down more than 75% from last year’s high, close to wiping out its whole gain during the pandemic bull market.
“If the Fed is guilty of causing this bear market, it was by overstimulating the bull market in 2021,” said Michael Shaoul, chief executive officer of Marketfield Asset Management. “The most important thing is that you don’t have a portfolio designed to do well in the kind of environment that existed between 2011 and 2021, because that environment no longer exists.”
The day-trader army has been slow to heed the Fed’s shift. The crowd has been buying dip after dip for the past few months even as losses piled up. To some market watchers, a bottom may not form until they capitulate.
While the term bear market may sound like a random Wall Street convention, it possesses a weirdly predictive link to the real world. Fourteen times the S&P 500 has completed the requisite 20% plunge in the last 95 years. In just three of those episodes did the American economy not shrink within a year. Among 14 recessions over the span, only three weren’t accompanied by a bear market.
How far can this selloff go? If history is any guide, more pain may lie ahead. Since 1927, the median bear market had tended to last 1.5 years, with the S&P 500 falling 34% over the span. Of all the previous 14 cycles, only three ended in less than four months.
Matching that median drawdown would put a floor at 3,179, or about 15% below the index’s recent levels.
“The Fed’s easy money along with the government handing out millions of stimulus checks created a massive bubble in stock prices during the pandemic. Now we’re paying the price,” said Adam Sarhan, chief executive officer of investment advisory service 50 Park Investments. “The wallstreetbets crowd may have perpetuated the problem, but they were more of a symptom of a greater issue driven by the Fed and extreme fiscal policy.”
—With assistance from Isabelle Lee.
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