The US stock market is in for a rough start of the trading year, but this is normal in midterm years, judging by historical standards. Are investors buying the dip, though?
2022 started with equities tumbling as central banks prepare to remove monetary accommodation. Now that war started in Eastern Europe, the international wave of sanctions against Russia threatens to send equity prices even lower.
Inflation runs hot in the United States as well as in other parts of the world. The COVID-19 pandemic triggered an unprecedented wave of monetary and fiscal stimulus, which resulted in an excessive rise in the prices of goods and services.
Rising inflation forces central banks to review their price stability mandate. As such, many of them in the developed world have already raised the interest rate or plan to.
One that is on track to start raising the rates is the Federal Reserve. It just ended its quantitative easing, and it signaled it would raise the federal funds rate in March. On top of that, it will begin the process of shrinking its balance sheet, thus further tightening the monetary policy.
As such, equities were hit from all parts. In addition, war sent oil prices above $120; therefore, inflation will likely keep rising..
This year is a midterm year in the United States, and the stock mark typically corrects in such a year. But if history tells us something, investors should buy the dip.
Buying the dip in midterm years makes sense
Midterm years typically see a large pullback. The intra-year pullback since 1950 was -17.1% on average, with 1974 recording the largest one – a pullback of -37.6%.
If we consider the oil crisis and the inflationary shock of 1974 and compare it with today’s conditions, then stocks may have more downside ahead. However, even if that is going to be the case, history tells us that investors should remain optimistic.
History tells us that, one year later, the average return exceeds 30%. Hence, investors will keep trying to pick a bottom and adjust their portfolio to position it for next year.